(Chapter Report, 05/29/98, GAO/RCED-98-169).
Pursuant to a congressional request, GAO reviewed whether privatization
will achieve the nuclear weapons waste clean-up goals expected by the
Department of Energy (DOE), focusing on: (1) what conditions need to be
present in order to successfully use fixed-price contracting for the
Office of Environmental Management's privatized clean-up projects; (2)
what alternative financing approaches could be used for Environmental
Management's privatization contracts; and (3) how alternative financing
methods for Environmental Management's privatization projects might
affect budget scoring.
GAO noted that: (1) fixed-price contracting, one key aspect of
Environmental Management's privatization program, can successfully be
used for environmental clean-up projects when certain conditions in the
Federal Acquisition Regulation are met; (2) when these conditions exist,
GAO found that the Office of Environmental Management has successfully
used fixed-price contracts for a variety of activities ranging from
cleaning up contaminated soils to decontaminating workers' uniforms; (3)
however, when these conditions do not exist, GAO found instances in
which clean-up projects being performed under fixed-price contracts
encountered cost increases and schedule delays; (4) in addition, risks
and issues that could affect the eventual performance of the contract
must be clearly defined; (5) total private financing represents one end
of a continuum of construction financing options; (6) private financing
transfers performance risk from the government to the private
contractor, but costs for this approach are significant because of the
increased risk assumed by the contractor; (7) total government financing
represents the other end of the continuum of options; (8) with
government financing, financing costs are minimized, but performance
risk which has also proven to be costly, remains with the government;
(9) in between these two extremes, other financing options exist that
attempt to strike a balance between performance risk and financing
costs; (10) how Environmental Management's privatization projects are
scored for budget purposes depends on the way certain key aspects of the
scoring rules are interpreted; (11) Environmental Management's
privatization projects are currently scored as service contracts; (12)
the use of alternative financing methods may change the interpretation
of the scoring guidelines for these projects; (13) as a result, under
all of the alternative financing options that GAO analyzed, the Office
of Environmental Management would need more budget authority earlier in
the projects and would also incur outlays sooner than under the Office
of Management and Budget's method; (14) a complex matrix of decision
factors needs to be considered when deciding who to contract for and
finance a cleanup project; and (15) once a contract type and financing
method are chosen, DOE and the contractor would need to carefully
develop a contract that clearly defines each party's roles and
accountability through provisions that allocate the project's risks
between parties.
--------------------------- Indexing Terms -----------------------------
REPORTNUM: RCED-98-169
TITLE: Department of Energy: Alternative Financing and Contracting
Strategies for Cleanup Projects
DATE: 05/29/98
SUBJECT: Nuclear waste disposal
Privatization
Contractor performance
Fixed price contracts
Cost effectiveness analysis
Budget administration
Cost control
Budget authority
Budget outlays
Atomic energy defense activities
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Cover
================================================================ COVER
Report to the Subcommittee on Energy and Water Development, Committee
on Appropriations, House of Representatives
May 1998
DEPARTMENT OF ENERGY - ALTERNATIVE
FINANCING AND CONTRACTING
STRATEGIES FOR CLEANUP PROJECTS
GAO/RCED-98-169
Contracting Strategies for DOE Cleanup Projects
(141076)
Abbreviations
=============================================================== ABBREV
DOE - Department of Energy
EM - Environmental Management
FY - fiscal year
GAO - General Accounting Office
LMAES - Lockheed Martin Advanced Environmental Systems
OMB - Office of Management and Budget
Letter
=============================================================== LETTER
B-279800
May 29, 1998
The Honorable Joseph M. McDade
Chairman
The Honorable Vic Fazio
Ranking Minority Member
Subcommittee on Energy and Water Development
Committee on Appropriations
House of Representatives
As requested, this report addresses the use of fixed-price
contracting and alternative financing strategies for the Department
of Energy's (DOE) Environmental Management program's approach for
privatizing cleanup projects. The report also examines how
alternative financing methods might affect budget scoring.
As arranged, unless you publicly announce its contents earlier, we
plan no further distribution of this report until 15 days after the
date of this letter. At that time, we will provide copies of the
report to the Secretary of Energy; the Director, Office of Management
and Budget; and other interested parties. We will also make copies
available to others upon request.
Please call me at (202) 512-8021 if you or your staff have any
questions. Major contributors to this report are listed in appendix
IV.
(Ms.) Gary L. Jones
Associate Director, Energy,
Resources, and Science Issues
EXECUTIVE SUMMARY
============================================================ Chapter 0
The Department of Energy's (DOE) Environmental Management program
faces the monumental task of cleaning up the environmental problems
created by nearly a half century of nuclear weapons production. This
effort is being performed primarily under cost-reimbursement
contracts. The Office of Environmental Management, however, has
found this approach to be very expensive and slow. In an effort to
reduce costs and improve timeliness, the Office proposed a
"privatization" approach with two key elements: fixed-price
contracts and private financing of the construction of waste
treatment facilities. Concerned about whether privatization will
achieve the goals expected by the Department, the Chairman and
Ranking Minority Member of the Subcommittee on Energy and Water
Development, House Committee on Appropriations, asked GAO to
determine (1) what conditions need to be present in order to
successfully use fixed-price contracting for Environmental
Management's privatized cleanup projects, (2) what alternative
financing approaches could be used for Environmental Management's
privatization contracts, and (3) how alternative financing methods
for Environmental Management's privatization projects might affect
budget scoring.
BACKGROUND
---------------------------------------------------------- Chapter 0:1
DOE has recognized that widespread weaknesses exist in its control of
its contractors' costs and activities and, in 1994, began a
Department-wide contract reform effort. The Office of Environmental
Management's privatization program is one aspect of that effort. In
fiscal years 1997 and 1998 combined, the Office requested about $2
billion for this program. GAO's previous reviews of those first two
privatization budget requests found that (1) some projects were not
needed, (2) the cost estimates for other projects were not complete
or reliable, and (3) some projects were not required by compliance
agreements and could be postponed.\1 Because of concerns about this
new program, the Congress appropriated only about $232 million of the
$1.006 billion requested for privatization in fiscal year 1998 and,
at the Secretary of Energy's suggestion, required the Office of
Environmental Management to submit detailed reports on privatization
contracts for a 30-day congressional review. The Office requested
$517 million for privatization in fiscal year 1999.
--------------------
\1 The Office of Environmental Management is responsible for
complying with numerous federal and state environmental requirements,
including the Comprehensive Environmental Response, Compensation, and
Liability Act; Resource Conservation and Recovery Act; and Clean
Water Act. DOE has signed agreements with federal and state
regulators to correct violations at its sites. These agreements
identify activities--generally called milestones--and schedules for
achieving compliance, many of which are legally binding and
enforceable.
RESULTS IN BRIEF
---------------------------------------------------------- Chapter 0:2
Fixed-price contracting, one key aspect of Environmental Management's
privatization program, can successfully be used for environmental
cleanup projects when certain conditions in the Federal Acquisition
Regulation are met. For example, the regulation finds that
fixed-price contracts are appropriate when projects are well-defined,
uncertainties can be allocated between the parties, and sufficient
price information and/or multiple competing bidders are available to
help determine a fair and reasonable price for the work. When these
conditions exist, GAO found that the Office of Environmental
Management has successfully used fixed-price contracts for a variety
of activities ranging from cleaning up contaminated soils to
decontaminating workers' uniforms. However, when these conditions do
not exist, GAO found instances in which cleanup projects being
performed under fixed-price contracts encountered cost increases and
schedule delays. In addition, risks and issues that could affect the
eventual performance of the contract--such as changes in
environmental regulations and the sufficiency of the existing data on
waste characterization to support the selection of a treatment
technology--must be identified and addressed so that each party's
responsibilities are clearly defined. Finally, as the Office of
Environmental Management has acknowledged, managing fixed-price
contracts takes managerial and procurement skills that are different
from those required for managing cost-reimbursement contracts.
Total private financing, the second key aspect of Environmental
Management's privatization program, represents one end of a continuum
of construction financing options. Private financing transfers
performance risk from the government to the private contractor, but
costs for this approach are significant because of the increased risk
assumed by the contractor. Total government financing represents the
other end of the continuum of options. With government financing,
financing costs are minimized, but performance risk, which has also
proven to be costly, remains with the government. In between these
two extremes, other financing options exist that attempt to strike a
balance between performance risk and financing costs. These options
include the government's guarantee of private debt financing,
performance payments, and progress payments. In weighing the risk
and financing costs of the options, consideration also needs to be
given to the options' impact on the ownership of waste treatment
facilities, government oversight, and the terms of contractors'
performance.
How Environmental Management's privatization projects are scored for
budget purposes depends on the way certain key aspects of the scoring
rules are interpreted. Although scoring determines the amount and
timing of budget authority and budget outlays and how they are
counted against the discretionary spending caps in the 1990 Budget
Enforcement Act (as amended), it does not affect the total cost of
projects. Environmental Management's privatization projects are
currently scored as service contracts, allowing the Office to defer
outlays until after the construction of facilities and equipment is
completed. However, the use of alternative financing methods may
change the interpretation of the scoring guidelines for these
projects. As a result, under all of the alternative financing
options that GAO analyzed, the Office of Environmental Management
would need more budget authority earlier in the projects and would
also incur outlays sooner than under the Office of Management and
Budget's (OMB) current method of scoring privatization projects. Two
key factors--facility ownership and assessment of government
risk--will drive how different financing methods could be scored.
A complex matrix of decision factors needs to be considered when
deciding how to contract for and finance a cleanup project. Among
the factors that need to be weighed are the following: (1) What
waste needs to be cleaned up, and how well is the waste
characterized? (2) How much competition is there among firms with
the necessary cleanup expertise? (3) What financing options are
available? (4) What risks are associated with the cleanup, and who
is best prepared to bear them? (5) How well equipped is DOE's staff
to design and oversee a cleanup contract? Once a contract type and
financing method are chosen, DOE and the contractor would need to
carefully develop a contract that clearly defines each party's roles
and accountability through provisions that allocate the project's
risks between parties; to define DOE's oversight role; and to
identify appropriate measures against which the contractor's
performance will be judged.
PRINCIPAL FINDINGS
---------------------------------------------------------- Chapter 0:3
KEY CONDITIONS NEEDED FOR
FIXED-PRICE CONTRACTING
-------------------------------------------------------- Chapter 0:3.1
Fixed-price contracting, one key aspect of Environmental Management's
privatization program, can successfully be used for environmental
cleanup projects when certain conditions in the Federal Acquisition
Regulation are met. For example, the regulation finds that
fixed-price contracts are appropriate when projects are well-defined,
uncertainties can be allocated between the parties, and sufficient
price information and/or multiple competing bidders are available to
help determine a fair and reasonable price for the work. While
fixed-price contracts are not suitable for every cleanup project,
this type of contract generally provides the most incentive for the
contractor to perform efficiently and to exercise cost control. The
risk of cost overruns from poor performance is generally borne by the
contractor, which helps to protect the government's interest. In
addition, most fixed-price contracts are awarded through an open
competition process that helps the government determine a fair price
for the work. When these conditions have been present, the Office of
Environmental Management has used fixed-price contracts to help
ensure cost-effective cleanup.
Previous studies of the Office of Environmental Management's handling
of environmental projects have found that when the scope of work has
not been clearly defined or the technology is not readily available,
the use of fixed-price contracts will not prevent significant cost
overruns and schedule delays. A 1996 study commissioned by the
Office of Environmental Management found that while cost and schedule
performance had improved since 1993, cost overruns on Environmental
Management's projects still ranged from 30 percent to 50 percent
beyond the original estimates.\2
However, when contracting for cleanup, the Office of Environmental
Management must also consider additional factors, such as the
availability of personnel to properly manage fixed-price contracts
and whether existing waste characterization data are sufficient to
support the selection or design of cleanup technology. Risks arising
from the unique characteristics of each project, such as the specific
type of waste to be treated, and more general risks, such as the
possibility of changes in environmental regulations or of funding
shortfalls, must be identified and allocated between the contractor
and DOE. Finally, the Office of Environmental Management has
recognized that its staff will need new and improved skills in the
areas of finance, procurement, and project management to effectively
implement the privatization program.
--------------------
\2 The Department of Energy, Office of Environmental Restoration and
Waste Management, Project Performance Study Update, Independent
Project Analysis, Inc. (Reston, Va.; Apr. 1996).
ALTERNATIVES TO TOTAL
PRIVATE FINANCING EXIST
-------------------------------------------------------- Chapter 0:3.2
The Office of Environmental Management's privatization program relies
on private financing, in lieu of government financing, for the
construction of needed waste treatment facilities. The contractor is
expected to finance these construction costs until the facilities are
completed and operations begin. Financing costs include the costs of
raising money, taxes, and profit. The contractor is expected to
provide the financing through some combination of its own funds
(owners' equity) and borrowed funds (debt). Private financing
transfers performance risk from the government to the contractor and
has the potential to reduce a project's overall cost because it
encourages the contractor, who has its own money at risk, to be more
efficient. However, private financing increases the performance risk
borne by the contractor, and as a result, private financing costs can
be significant. Although other financing options exist that can
lower financing costs by increasing the use of government financing,
these options increase the risk to the government because the
contractor's performance incentive may be reduced. Any added
performance risk facing the government under these options can result
in significant costs that may more than offset the benefit of lower
government financing costs.
Other financing strategies include options such as a government
guarantee of private-sector debt financing, partial payments to the
contractor during construction with final payment contingent on
successful waste treatment, and progress payments during
construction. GAO analyzed the impact of financing alternatives,
using the financing schedule from the existing privatization contract
for the Advanced Mixed Waste Treatment Project at the Idaho National
Engineering and Environmental Laboratory. GAO found that financing
costs varied from $137.9 million for full private financing to $47.1
million for the progress payment option. Finally, with total
government financing, no private financing costs are incurred because
contractors are paid as costs are incurred.
While government financing of construction costs appears to be less
costly than private financing, the government assumes a much greater
performance risk, that is, the chance that the facility the
government has financed will not be successfully completed or will
experience significant cost growth. The potential costs associated
with these risks could offset--or more than offset--any apparent
advantage gained by using lower-cost government financing. According
to DOE's past experience with major government-financed projects,
these risks are real. For example, GAO found that from 1980 through
1996, 31 of DOE's 80 major systems acquisitions were terminated
before completion after the government had expended over $10 billion.
For 15 projects that were completed, final costs exceeded the
original estimates by an average of 63 percent.\3 The cost of
additional performance risk is difficult to quantify but must be
considered in any decision to reduce private-sector risk and lower
financing costs by using full or partial government financing.
In addition, as the proportion of government financing increases, the
government may want to assume more of an ownership role and have to
exercise more oversight. Government ownership of a treatment
facility could place the government in a better negotiating position
for future cleanup services--especially if private ownership creates
a monopoly for the private sector because the facility is the only
one capable of providing the required treatment services. This
potential benefit of government ownership must be weighed against the
negative consequences of inadequate oversight by DOE. Finally, in
considering the impact of financing options on performance risk, it
is important to note that the actual terms of performance in the
contract will determine the nature of the performance risk borne by
the government and the private contractor.
--------------------
\3 Department of Energy: Opportunity to Improve Management of Major
System Acquisitions (GAO/RCED-97-17, Nov. 26, 1996).
HOW PROJECTS ARE STRUCTURED
MAY CHANGE THEIR BUDGETARY
IMPACT
-------------------------------------------------------- Chapter 0:3.3
Under the Budget Enforcement Act of 1990 (as amended), discretionary
spending is constrained by caps or dollar limits on budget authority
and outlays.\4
When federal agencies enter into agreements to acquire or use capital
assets such as waste treatment facilities, budget scoring determines
when and how much budget authority and outlays will be counted
against the caps. Depending on the way scorekeeping guidelines are
interpreted, GAO found that changing the way Environmental
Management's privatization projects are financed could result in more
budget authority and outlays being scored, or budget authority and
outlays being scored sooner, than under the Office of Environmental
Management's current privatization approach. Under the guidelines,
how Environmental Management's privatization projects are scored
depends on two key factors--whether the contractor or the government
will own the facility being constructed and, if the government will
have ownership, what degree of risk the government assumes.
As Environmental Management's privatization program is currently
structured, the private contractor will own the facilities, and OMB
is scoring the projects as service contracts. This scoring allows
the Office of Environmental Management to defer outlays until after
the construction of facilities and equipment is completed. In
general, if the government will ultimately own the facility, budget
authority and outlays would most likely be scored earlier than if the
private contractor retains ownership. In addition, use of a loan
guarantee would require the estimation of a subsidy cost (primarily
an estimate of the risk of default), which could add significantly to
the amounts of budget authority and outlays that would be needed
during the construction period. Under all of the alternative
financing options that GAO analyzed, the Office of Environmental
Management would need more budget authority earlier in the projects
and would also incur outlays sooner than under OMB's current method
of scoring privatization projects. However, GAO has found that when
decisions on capital asset acquisition are driven by budget scoring
constraints, the government may pay more for the asset in the long
run than necessary.\5
--------------------
\4 Budget authority is the authority provided by law to enter into
financial obligations that will result in immediate or future outlays
of federal funds. Outlays are the actual issuance of checks,
disbursement of cash, or electronic transfers of funds made to
liquidate a federal obligation.
\5 Budget Issues: Budgeting for Federal Capital (GAO/AIMD-97-5, Nov.
12, 1996).
RECOMMENDATIONS
---------------------------------------------------------- Chapter 0:4
This report does not contain recommendations.
AGENCY COMMENTS
---------------------------------------------------------- Chapter 0:5
GAO provided a draft of this report to DOE for its review and
comment. Overall, DOE stated that GAO's report represented a
constructive attempt to clarify some of the important issues involved
in alternative financing for DOE's cleanup projects. DOE also agreed
with GAO's statement that while government financing appears less
costly, the greater performance risk the government assumes when it
finances a project, and the potential costs associated with this
greater risk, could offset any apparent advantage gained by using
lower-cost government financing. However, DOE believed that GAO
should have attempted to compensate for these potential increases in
costs in the model it used to estimate the impact of financing
alternatives. GAO did not perform the adjustment DOE suggested
because GAO did not have a factual basis for assigning levels of cost
growth to all of the various financing alternatives it analyzed.
Instead, GAO emphasized throughout the report that cost growth was a
possibility as the government took on more performance risk and cited
available evidence from independent studies and GAO reports to
indicate how large this growth had been under DOE's existing
contracts. Where appropriate, GAO made changes to the report in
response to DOE's specific comments. DOE's comments are included as
appendix III.
BACKGROUND
============================================================ Chapter 1
Since its inception in 1989, the Environmental Management (EM)
program has used management contractors to perform cleanup projects
and operate its major sites. While EM contracts authorize fees
(i.e., profits) to motivate management contractors to high-quality
performance, subpar performance in the areas of controlling costs and
meeting schedules has repeatedly occurred. For example, a 1996 study
commissioned by EM found that while cost and schedule performance had
improved since 1993, cost overruns on EM projects still ranged from
30 percent to 50 percent.\1 More broadly, in November 1996, we found
that, of 15 major system acquisitions completed by the Department of
Energy (DOE) from 1980 through 1996,\2 the projects cost an average
of 63 percent more than the original cost estimates and were
completed an average of 71 months late.\3 More recently, DOE's
Inspector General found a number of problems with the implementation
of performance incentives in management contracts, including DOE
having paid incentives for work that was not completed by the
required performance date, for work done before performance measures
were established, and for work that was not done at all.\4
EM's privatization program is one aspect of DOE's Department-wide
effort that began in 1994 to reform the Department's contracting
practices, including an increased emphasis on the use of performance
incentives and fixed-price contracts. EM's privatization approach
currently has two key elements. First, privatization uses
fixed-price contracts under which the contractor is paid a fixed
amount for acceptable goods and services regardless of the costs the
contractor incurs. Second, privatization contractors are expected to
provide private financing for the construction of facilities, if
needed, to produce the final product EM is buying. The privatization
program receives a separate appropriation to cover the capital
investment portion of these contracts. However, in the event the
contract is terminated by the government before completion, the
privatization funding will be used to reimburse the contractor for
its capital investment. If the contract is continued through
completion, the privatization funding will be used to repay the
capital investment as acceptable goods or services are provided.
Although this is the current approach to privatization, according to
DOE officials, EM's privatization program will continue to evolve
over time as DOE learns more through evaluating actual business
proposals.
The privatization program was first funded in fiscal year (FY) 1997,
when the Congress appropriated $330 million to support five projects,
including the Tank Waste Remediation System at Hanford (see table 1
below). In FY 1998, the Congress provided an additional $200 million
for one existing project and four new projects, including Spent
Nuclear Fuel projects at Savannah River and at Idaho, a
transportation project at Carlsbad, and a waste disposal project at
Oak Ridge. In addition, the Congress provided $31.7 million in FY
1998 through the Defense Facilities Closure Projects account for two
smaller privatization projects at EM's Fernald Environmental
Management Project in Ohio. The FY 1999 budget request includes
about $517 million to continue work on ongoing privatization projects
at Hanford, Idaho, and Oak Ridge, and one new transportation project
administered by the Carlsbad Area Office.
Table 1.1
Status of EM's Proposed Privatization
Projects, FYs 1997 Through 1999
(Dollars in millions)
Appropriations
---------------------- ----------------------------------
Actual Requested
---------------------- ----------
Project Current
(location) status FY 1997 FY 1998\a FY 1999
---------------------- ---------- ---------- ---------- ----------
Tank Waste Remediation Phase I $170.0 $115.0 $330.0
System (Hanford) contract
awarded,
Part A
complete,
Part B
under
review
Broad Spectrum Low- Canceled 15.0 0.0 \b
Level Mixed Waste from
Treatment (Oak Ridge) privatiza
tion
funding;
continuin
g from
operating
funding
Advanced Mixed Waste Ongoing; 70.0 0.0 87.0
Treatment Project contract
(Idaho) awarded
December
1996
Waste Water Treatment Canceled 10.0 0.0 \b
Plant (Rocky Flats) from
privatiza
tion
program
Transuranic Waste Procuremen 65.0 0.0 \c
Treatment (Oak Ridge) t process
ongoing
Contact Handled Ongoing \d 21.0 \c
Transuranic Waste project
Transportation
(Carlsbad)
Spent Nuclear Fuel Dry Procuremen \d 27.0 30.0
Storage (Idaho) t ongoing
Environmental Procuremen \d 5.0 50.0
Management Waste t ongoing
Management Disposal
(Oak Ridge)
Spent Nuclear Fuel Ongoing \d 25.0 \c
Transfer and Storage project\e
(Savannah River)
Remote Handled New FY \d \d 19.6
Transuranic Waste 1999
Transportation project
(Carlsbad)
Waste Pits Remedial Project \d 0.0 \b
Action (Fernald) transferr
ed to
Defense
Facilitie
s Closure
Projects
account
Silo 3 Residue Waste Project \d 0.0 \b
Treatment (Fernald) transferr
ed to
Defense
Facilitie
s Closure
Projects
account
----------------------------------------------------------------------
\a An additional $7 million in non-project-specific funds was
appropriated.
\b Project will not be funded through the privatization account.
\c No funding requested in this fiscal year.
\d Project was not proposed for privatization funding until the
following fiscal year budget.
\e This project has limited funding to date and is in the
preconceptual design stage.
Source: Compiled by GAO from DOE's data.
In 1997, we reported problems with DOE's FY 1997 and FY 1998
privatization budget requests.\5 These included estimated costs for
projects that did not always include all relevant costs, such as
those that would be incurred by the sites' management contractors to
support privatized projects. In addition, funding for some projects
was not needed when requested. For example, although funds were
requested for FY 1998, we found that the Power Burst Facility at
Idaho would not be ready for deactivation until FY 1999. In
addition, in computing cost savings, EM did not always compare
projects of comparable scope, as in the case of the Savannah River
M-Area Mixed Waste Tank Remediation project. Finally, in its fiscal
year 1997 budget request, EM cited the Idaho Pit 9 project as a
successful privatization on the basis of its placement of a
fixed-price contract. However, we found that, since the contract was
let, the project has fallen significantly behind schedule and that EM
and its management contractor are involved in a disagreement with the
fixed-price subcontractor over a number of performance issues. The
future course, including the ultimate cost, of this project is
uncertain until these disagreements have been formally resolved.\6
These early problems with implementing the privatization program have
led to concern in the Congress about whether privatization, as
defined by EM, is appropriate for large, capital-intensive projects.
These concerns led the Congress to deny a substantial portion of EM's
FY 1998 privatization budget request and to require EM to submit
detailed reports analyzing privatization contracts for a 30-day
congressional review before incurring any additional contractual
obligations. Specifically, DOE cannot (1) enter into a new
privatization contract, (2) exercise authorization to proceed with a
privatization contract, or (3) extend a privatization contract by
more than 1 year without providing the Congress an opportunity to
review the proposed action.
--------------------
\1 The Department of Energy, Office of Environmental Restoration &
Waste Management, Project Performance Study Update, Independent
Project Analysis, Inc. (Reston, Va., Apr. 1996).
\2 A major system acquisition is defined as a project critical to
fulfilling an agency's mission, entailing the allocation of
relatively large amounts of resources and warranting special
management attention.
\3 Department of Energy: Opportunity to Improve Management of Major
System Acquisitions (GAO/RCED-97-17, Nov. 26, 1996).
\4 According to DOE officials, DOE has recovered $2.8 million in
questioned fees following the 1997 Inspector General's review.
\5 See Nuclear Waste: DOE's Estimates of Potential Savings From
Privatizing Cleanup Projects (GAO/RCED-97-49R, Jan. 31, 1997) and
DOE's Fiscal Year 1998 Budget Request (GAO/RCED-97-171R, July 21,
1997).
\6 See Nuclear Waste: Department of Energy's Project to Clean Up Pit
9 At Idaho Falls is Experiencing Problems (GAO/RCED-97-180, July 28,
1997) and Nuclear Waste: Department of Energy's Pit 9 Cleanup
Project Is Experiencing Problems (GAO/T-RCED-97-221, July 28, 1997).
OBJECTIVES, SCOPE, AND
METHODOLOGY
---------------------------------------------------------- Chapter 1:1
The Chairman and Ranking Minority Member of the House Committee on
Appropriations, Subcommittee on Energy and Water Development, asked
us to review EM's privatization program. Specifically, we determined
(1) what conditions need to be present in order to successfully use
fixed-price contracting for EM privatization cleanup projects, (2)
what alternative financing approaches could be used for EM
privatization contracts, and (3) how alternative financing methods
for EM privatization projects might affect budget scoring.
To determine the elements needed to successfully use fixed-price
contracts for cleanup projects, we visited three Department of Energy
sites with active privatization programs--Hanford, Idaho, and Oak
Ridge. During our site visits, we gathered information on cleanup
projects formally proposed for privatization. We also reviewed a
judgmentally selected group of cleanup projects that used an
alternative to the traditional method of having the management
contractor perform the work on a cost-reimbursement basis, such as
the use of various forms of fixed-price and cost-reimbursement
incentive contracts. In addition, to determine what factors DOE
considers in selecting the type of contract for cleanup projects, we
interviewed the privatization coordinators, contracting staff, and
project management staff at each of the sites. At DOE headquarters,
we also interviewed officials from (1) EM's Office of Program
Integration, (2) DOE's Contract Reform and Privatization Project
Office, and (3) DOE's Office of Procurement and Assistance
Management. We researched the Federal Acquisition Regulation for
information on the various types of contracts, their major features,
and criteria for selecting which type of contract to use. Finally,
we interviewed officials from the Army Corps of Engineers'
Environmental Division.
To identify alternative financing approaches for EM's privatization
contracts, we interviewed officials of companies currently
participating in privatization projects and representatives of
financial consulting firms that help clients secure capital for
environmental and construction projects. We also discussed project
financing issues with the DOE headquarters and field staff listed
above and searched relevant financial literature to gather background
on issues such as private firms' capital structures and estimation of
financing costs. Finally, we constructed a model using actual data
from the contract for the Idaho Advanced Mixed Waste Treatment
Project. We used the model to determine the comparative costs of
financing under several scenarios. We received assistance in the
modeling effort from our Office of the Chief Economist.
To evaluate how alternative financing and contracting approaches
might affect budget scoring of EM's privatization projects, we
analyzed the scoring guidelines in the Office of Management and
Budget's (OMB) Circular A-11. We also discussed budget scoring
issues with officials of OMB and the Congressional Budget Office. We
received assistance in this effort from our Accounting and
Information Management Division.
We provided a draft of this report to DOE for its review and comment.
DOE's comments and our response are included as appendix III and are
discussed in the chapters where appropriate. We performed our review
from July 1997 through May 1998 in accordance with generally accepted
government auditing standards.
CERTAIN KEY CONDITIONS NEED TO BE
PRESENT IN ORDER TO USE
FIXED-PRICE CONTRACTING
============================================================ Chapter 2
Fixed-price contracts can be used for cleanup projects, including
privatization projects, when certain conditions in the Federal
Acquisition Regulation are met. For example, the regulation finds
that fixed-price contracts are appropriate when projects are
well-defined, uncertainties can be allocated between the parties, and
sufficient price information and/or multiple competing bidders are
available to help determine a fair and reasonable price for the work.
In addition, EM's projects place special demands on both EM and the
contractor which must be considered when selecting the contracting
strategy that will be most cost-effective. For example, contracts
for EM's projects must consider the need to indemnify contractors for
accidents involving nuclear materials. Over the past few years, EM
has had some success with fixed-price cleanup contracts; however,
experiences in Idaho and Oak Ridge illustrate that fixed-price
contracting is not appropriate for every cleanup project.
FACTORS TO CONSIDER WHEN
SELECTING FIXED-PRICE CONTRACTS
---------------------------------------------------------- Chapter 2:1
The Federal Acquisition Regulation finds that fixed-price contracting
is the preferred type of contract for government acquisitions when
certain conditions are met. In general, a fixed-price contract
provides the most incentive for the contractor to perform efficiently
and to exercise cost control. The risk of cost overruns from poor
performance is generally borne by the contractor, which helps to
protect the government's interest. In addition, most fixed-price
contracts are awarded through an open competition process that helps
the government determine a fair price for the work. The conditions
most conducive to using fixed-price contracts include the following:
-- a clearly defined scope of work;
-- low probability of major changes to work scope or conditions to
avoid costly renegotiation of price;
-- existence of proven technologies that can be applied with no
more than limited modifications;
-- sufficient price information and/or multiple competing bidders
to aid in determining a fair price for the work, that is, a
price that minimizes the cost to the government while providing
a fair profit to the contractor;
-- easily verifiable performance measures to facilitate monitoring
progress toward project completion; and
-- thorough analysis of risks and appropriate allocation or sharing
of risks so that the party best able to manage each risk is
responsible for addressing it.
EM HAS USED FIXED-PRICE
CONTRACTS SUCCESSFULLY
---------------------------------------------------------- Chapter 2:2
When the conditions discussed above have been present, EM has used
several varieties of fixed-price contracts to help ensure
cost-effective cleanup. For example, Idaho and Hanford have used
fixed-price contracts for laundry services for items such as
contaminated workers' uniforms. DOE has estimated the savings from
the Idaho contract at $3 million to $8 million over the next 10
years, and savings from the Hanford contract are estimated to be
about $4.5 million per year. Hanford also contracted for the
treatment of 24,000 to 26,000 gallons of tri-butyl phosphate wastes
on a fixed-price contract at a total savings of about $1.5 million.
At Savannah River, the M-Area Mixed Waste Tank Remediation project
was privatized in 1993. While the contractor has experienced some
technical problems, the contractor expects to successfully complete
waste treatment operations under the terms of the original contract.
EM estimates this contract will save a total of $19 million to $28
million. Finally, at Idaho the fixed-price contract for low-level
waste treatment has a unit cost of about one-half that of the on-site
facility that formerly performed this work.
While EM's focus in pursuing fixed-price contracts has been on saving
money, fixed-price contracts can incorporate incentives that
accommodate other goals. For example, Oak Ridge used an incentive to
reduce the amount of waste created in its contract for the cleanup of
the St. Louis North County site of the Formerly Utilized Sites
Remedial Action Program. If the contractor shipped less waste,
primarily soil, to the designated disposal site than estimated in the
contract, DOE avoided the costs of waste disposal. As an incentive
for the contractor to minimize waste shipments, DOE split the value
of those savings with the contractor. Similarly, the contracts for
the Oak Ridge Broad Spectrum Low-Level Mixed Waste Treatment are
planned to include incentives for minimizing the volume of waste to
be disposed of or stored after treatment.
If a fixed-price contract does not appear to be cost-effective, other
contracting methods may offer similar benefits. One such alternative
is the use of incentives in cost-reimbursement contracts to motivate
the contractor to achieve better cost control and performance. For
example, Oak Ridge and its management contractor agreed to
cost-plus-incentive-fee contracts for several cleanup projects.
While the contractor's costs were covered, the only way for the
contractor to earn a fee or profit on the work was to meet or improve
on cost and schedule targets. Under this contract, if the contractor
missed the targets by specified amounts, the fee earned could be a
negative amount, that is, a loss. The first of these incentive
projects was for the demolition of a powerhouse complex on the K-25
site. The project was completed 6 months ahead of schedule and $5
million under target cost.\1 Under another cost-plus-incentive-fee
contract for the demolition of cooling towers on the K-25 site, the
contractor completed the project 2 months ahead of schedule and more
than $5 million under target cost, partly by finding an innovative
way to dispose of contaminated water that had accumulated in the
basins under the cooling towers. (See app. I for further discussion
of alternative contract types and illustrative examples of EM's
cleanup contracts using them.)
--------------------
\1 However, Oak Ridge officials stated that the contractor had earned
the bulk of its cost incentive fee by awarding fixed-price
subcontracts for less than the estimated amounts included in its bid.
Subsequently, DOE officials limited the amount of cost incentive fee
that the contractor could earn on the basis of subcontract awards.
See Department of Energy: Contract Reform Is Progressing, but Full
Implementation Will Take Years (GAO/RCED-97-18, Dec. 10, 1996) for a
fuller discussion of this contract.
ADDITIONAL FACTORS BEYOND THE
CONTRACT TYPE NEED TO BE
CONSIDERED
---------------------------------------------------------- Chapter 2:3
When contracting for cleanup, EM must also consider additional
factors that occur because of the unique characteristics of cleanup
projects and the special conditions pertaining to working in the DOE
complex. These factors include several types of risks that must be
shared or allocated between EM and the contractor, the unique aspects
of each project, and the availability of personnel to properly manage
fixed-price procurements and projects.
Risks must be identified and addressed in the contract so that each
party's responsibilities are clearly defined. Some risks, such as
the possibility of changes in environmental regulations during a
project's lifetime, third-party liability and insurance,
environmental indemnification, construction cost and schedule
changes, interest rate fluctuations, material cost escalation, lack
of sufficient appropriations to support the original schedule, and
termination for convenience of the government, are not unique to EM's
cleanup projects but must still be considered in estimating the
contract price. Other risks, such as indemnification for accidents
involving nuclear materials, working with EM's stakeholders, and
addressing the concerns of unionized workers at EM sites, generally
are not found outside of the DOE complex. There are also risks
inherent in cleanup projects, such as determining whether the
existing waste characterization data are sufficient to support
technology selection or design, and how new or existing treatment
technologies will perform on a specific waste stream. EM also faces
risks such as pre-existing site conditions and paying contractors for
idle facilities if, for example, EM or the management contractor
fails to deliver waste for treatment as specified in the contract.
EM's 1997 Privatization Project Team Staffing Report states that
"[i]mplementing privatization will require the modification of the
Department's traditional project management practices."\2 When
compared to starting cleanup projects using management contractors,
EM officials acknowledge that using fixed-price contracts requires
additional project definition and planning before and during the
procurement process. Under management contracts, EM managers could
make changes as the project progressed without explicit recognition
of the costs of those changes. While fixed-price contracts can help
to reduce costs and improve performance when used properly, the cost
of any changes to work scope must be negotiated with the contractor,
potentially raising the price of the contract. In recognition of
that fact, EM's Privatization Management Plan\3
requires that privatization contracts contain a clause limiting who
can direct the contractor to make changes that could affect the scope
(and, implicitly, the price) of the contract. Not all EM managers
are comfortable using fixed-price contracts because of this limited
flexibility to make changes after the contract is awarded.
Using fixed-price contracts requires that employees have a different
skill mix than EM has needed in the past to manage cleanup projects
through its management contracts. The Project Team Staffing report
also highlighted some areas in which EM managers will need new or
strengthened skills to effectively implement the program. For
example, the report notes that privatization procurements require
more effort in the early stages of procurement development and more
staffing in contract administration and monitoring. The report also
recognizes that EM project teams have not traditionally had all of
the skills--such as those associated with corporate budgeting,
capital market analysis, financing of employee benefit programs, and
hands-on experience developing complex schedules and project
management plans--needed to ensure that privatization procurements
and contracts are fully executable. Consequently, some project
managers and procurement staff may need additional training to use
fixed-price contracts to full advantage. One step DOE has taken to
address these new demands on its staff is to require that all
privatization procurement requests for proposals and contracts be
sent to headquarters for review and concurrence by functional
experts, staff in the Office of Procurement and Assistance
Management, and other key officials before they are issued. In
addition, EM management is working with the field offices to develop
a new training curriculum to provide project managers and procurement
staff with additional skills so that they can better recognize when
to use fixed-price contracts.
Our work has repeatedly highlighted continuing problems with DOE's
management of projects and contracts. In November 1996, we reported
that lack of sufficient DOE personnel with the appropriate skills to
oversee contractors' operations was one of the key factors underlying
the cost overruns and schedule slippages DOE has experienced in major
systems acquisitions.\4 In March 1997, we reported that a key cleanup
project at EM's Fernald, Ohio, site has experienced significant delay
and cost growth because DOE did not assign a sufficient number of
staff with the proper skills to the project.\5 Finally, as we discuss
in detail in the next section, Idaho has experienced problems with
the Pit 9 cleanup, which DOE chose to privatize, in part, because of
the lack of in-house expertise in large remediation projects.\6
--------------------
\2 Department of Energy, Report to the Assistant Secretary for
Environmental Management: Privatization Project Team Staffing (Aug.
24, 1997).
\3 Department of Energy, Environmental Management Privatization
Program Management Plan (Sept. 1997).
\4 See Department of Energy: Opportunity to Improve Management of
Major System Acquisitions (GAO/RCED-97-17, Nov. 26, 1996).
\5 See Department of Energy: Management and Oversight of Cleanup
Activities at Fernald (GAO/RCED-97-63, Mar. 14, 1997).
\6 See Nuclear Waste: Department of Energy's Project to Clean Up Pit
9 at Idaho Falls Is Experiencing Problems (GAO/RCED-97-180, July 28,
1997).
USING FIXED-PRICE CONTRACTS
DOES NOT GUARANTEE THAT EM WILL
ACHIEVE THE COST REDUCTION AND
PERFORMANCE ANTICIPATED
---------------------------------------------------------- Chapter 2:4
Without careful attention to devising the right type of contract, the
unique aspects of cleanup projects, and proper management oversight,
EM may not get the cost reduction and performance it anticipates from
using fixed-price contracts. As we noted in our recent report on
DOE's estimates of potential savings from privatizing cleanup
projects,\7 DOE's use of fixed-price contracts has not always been an
effective method to minimize cost growth on projects. EM contracted
with a consulting firm, which issued a report in November 1993\8 and
an update in April 1996,\9 to review EM's performance on cleanup
projects performed under both cost-reimbursement and fixed-price
contracts. The report found that EM's costs for environmental work
were substantially higher than private industry's. In 1993, it found
that growth from estimated to actual costs on a sample of 65 projects
with fixed-price contracts was almost 75 percent. In the 1996
update, it reported that EM's projects typically cost 25 percent to
40 percent more than similar projects in the private sector. While
it found that EM's cost performance had improved since the 1993
review, EM was still experiencing cost growth in the range of 30
percent to 50 percent over original estimates. It concluded that
this cost growth has occurred primarily because projects were poorly
defined, leading to change orders after the contracts were signed.
In 1994, Lockheed Martin Idaho Technologies Company, the management
contractor at Idaho, awarded a fixed-price subcontract to Lockheed
Martin Advanced Environmental Systems (LMAES) for the cleanup of Pit
9.\10 Pit 9 is about one acre in size and contains various wastes
ranging from contaminated rags to plutonium-contaminated sludge. The
cleanup was expected to cost about $200 million\11 and to be
completed in 1999. DOE chose a fixed-price approach for the Pit 9
project because Department officials believed a fixed price would
help limit the project's total cost and provide an incentive for
contractors to use efficient practices in carrying out the project by
shifting the risk of nonperformance to the contractors. During the
early stages of the procurement process, concerns arose about the
appropriateness of a fixed-price approach given the uncertainty about
the contents of the pit. Nevertheless, senior DOE officials decided
that this approach was warranted, given the high costs and the
inefficient performance the Department had experienced with
cost-reimbursement contracts, private industry's expressed interest
in performing the cleanup using a fixed-price arrangement, and the
potential benefits of the approach.
However, in March 1997, when the subcontractor estimated that project
completion would be 26 months behind schedule, LMAES requested an
equitable adjustment and conversion of the contract type to cost
reimbursement. LMAES claims that DOE failed to properly describe the
contents of the pit and that DOE and its management contractor have
interfered with the contractor's operations, preventing it from
meeting its contractual commitments. DOE and the management
contractor at Idaho disagree with LMAES' claims and claim, in their
turn, that the contractor failed to properly manage the project.
LMAES has requested a total of $257 million for costs through June
1997, $78 million more than the project was expected to cost, but the
waste retrieval and processing facilities are not ready and no wastes
have been retrieved or processed. As of May 1998, these issues
remain unresolved and the project remains stalled.
In Oak Ridge, a multiphase cleanup project was discontinued after the
first phase because the treatment system proposed by the contractor
was too expensive and treatment was determined not to be necessary.
The management contractor, Lockheed Martin Energy Systems, attempted
to contract with multiple firms for the first phase of the West End
Treatment Facility project to design a treatment process for a fixed
payment. However, they discovered that because the project required
each contractor to be able to perform several different types of
activities--such as removing sludge from storage tanks, transferring
the waste to a treatment facility, and treating the waste--only one
firm submitted a responsive bid. Ultimately, the management
contractor recommended to EM that the second phase procurement for
waste treatment be canceled, but because only one contract had been
let, and that contractor had invested more than the fixed amount, EM
ended up paying a negotiated equitable adjustment that more than
doubled the cost of the first phase contract from $400,000 to about
$900,000. In retrospect, EM and management contractor officials told
us that they should have reconsidered the project when only one
responsive bid was received and determined why they did not receive
the level of competition they were expecting. The lack of
competition in the procurement for the first phase of this project
ultimately led to increased costs when the later phases of the
project were canceled.
Another project at Idaho for the long-term storage of damaged fuel
from the Three Mile Island reactor has been delayed and the
fixed-price contract has been modified 12 times. The Idaho project
managers stated that a fixed-price contract would probably not have
been chosen for this project if they had known that a change from DOE
regulation to Nuclear Regulatory Commission regulation would be made
and that the condition of temporarily stored fuel was different from
what was expected at the time the contract was awarded. In this
instance, the delays and contract modifications have added about $4
million (or 33 percent) to the cost of the project, raising the cost
from $12 million to $16 million.
--------------------
\7 See Nuclear Waste: DOE's Estimates of Potential Savings From
Privatizing Cleanup Projects (GAO/RCED-97-49R, Jan. 31, 1997).
\8 The Department of Energy, Office of Environmental Restoration and
Waste Management, Project Performance Study, Independent Project
Analysis, Inc. (Reston, VA., Nov. 30, 1993). Because the study
included both completed and ongoing projects, some of the costs were
estimated.
\9 The Department of Energy, Office of Environmental Restoration &
Waste Management, Project Performance Study Update, Independent
Project Analysis, Inc. (Reston, Va., Apr. 1996). The study did not
update EM's performance on fixed-price contracts.
\10 The procurement and project evaluation was performed primarily by
EG&G, the predecessor management contractor.
\11 GAO estimated the total cost of this contract to be about $200
million, including $179 million for the cleanup and a $21 million
deferred payment for equipment that will be due to the contractor if
it does not receive additional contracts during which the equipment
can be reused.
ALTERNATIVE FINANCING APPROACHES
EXIST FOR EM'S PRIVATIZATION
PROGRAM
============================================================ Chapter 3
EM's privatization program relies on private financing of
construction costs to create a performance incentive for the
contractor to construct a successful facility. However, private
financing increases the performance risk borne by the contractor, and
as a result, private financing costs can be significant. Other
financing options exist that would leave some performance risk with
the government by increasing the use of government financing.
However, the risk associated with these options could result in
significant costs to the government that may offset--or more than
offset--the benefit of lower financing costs. In weighing the
financing and risk costs, consideration should also be given to the
impact of the option selected on ownership of facilities, government
oversight, and the terms of contractors' performance.
EM'S PRIVATIZATION PROGRAM
RELIES ON PRIVATE FINANCING
---------------------------------------------------------- Chapter 3:1
EM's privatization program relies on private financing for the
acquisition of needed cleanup facilities and equipment. Under EM's
approach, the contractor will own all facilities required to deliver
the desired cleanup services. The contractor is responsible for all
construction costs, including the development of technologies,
procurement of equipment, and new-facility construction. In
addition, the contractor is expected to finance these construction
costs until the facilities are completed and operations begin.
Financing cost includes the costs of raising money, taxes, and
profit. The contractor is expected to provide the financing for
these costs through some combination of its own funds (owners'
equity) and borrowed funds (debt). As the contractor begins to
deliver cleanup services, the contractor is paid for its operating
costs. In addition, each year the contractor is paid a portion of
the construction and financing costs it has incurred until these
costs are eventually recouped. These payments for the contractor's
construction and financing costs are directly tied to the amount of
cleanup services it provides.
EM EXPECTS PRIVATE FINANCING TO
CREATE PERFORMANCE INCENTIVE
FOR CONTRACTORS
---------------------------------------------------------- Chapter 3:2
EM expects that its private financing approach will ensure that
contractors are properly motivated to perform successfully in two
ways. First, because a contractor's recoupment of its investment is
dependent on performance, it will have a greater incentive to
perform. Second, because the contractor is financing construction
through the use of debt, EM believes that the lenders will provide
third-party oversight to ensure that their investment is sound. They
are likely to hire various consultants to review all aspects of the
contractor's plans to ensure that the project is feasible, which
provides assurance that the likelihood of contractor failure is
minimized. In addition, if the contractor does fail to complete the
project for some reason, this oversight provides further assurance to
the lenders that they could take over the project, bring in another
contractor to complete it, and recoup their investment.
While fixed-price contracting is believed to provide some greater
control over price, EM believes that private financing is key to
ensuring that the project is successful. With only a fixed-price
contract and no private financing at stake, EM is concerned that it
will have little recourse against a contractor that does not deliver
as promised. EM's concern stems from the fact that contractors that
have expressed an interest in large cleanup projects have indicated
that they will form separate subsidiaries to perform the contract,
using a commonly employed approach known as limited liability
companies, that are heavily debt-financed and have few assets of
their own. Without appropriate warranties from the parent company,
the use of these limited liability companies can financially and
legally isolate the project from the parent companies and limit the
parent companies' liability for contract performance. However, under
such an arrangement, EM is concerned that if the contractor fails to
meet the terms of the contract, the contractor could shut down,
leaving EM with an inoperable facility and little hope for recourse
against a heavily debt-financed company with few assets.
COST OF PRIVATE FINANCING CAN
BE SIGNIFICANT
---------------------------------------------------------- Chapter 3:3
The total capital cost of a facility consists of the construction
costs (including design, construction, and equipment procurement
costs) and the financing costs. Private financing costs can be high
and can significantly increase the total capital costs. For example,
under DOE's contract with British Nuclear Fuels Limited, Inc., to
build the Advanced Mixed Waste Treatment Project in Idaho, EM will
pay construction costs of $244.6 million in 1998 dollars.\1 Private
financing of these costs will add another $137.9 million, more than
half of the construction costs. As larger cleanup projects are
considered by EM, such as Hanford's Tank Waste Remediation System
project, which is expected to have construction costs of more than $1
billion, concerns have been raised about whether private financing is
a realistic alternative.
--------------------
\1 In order to make a proper comparison between the different
financing options, which have different timing of payments, we valued
the construction and financing costs in present value 1998 dollars.
Consistent with GAO's policy, we used a discount rate of 6 percent,
which is the interest rate on marketable Treasury debt with maturity
comparable to that of the projects being evaluated.
OTHER CONSTRUCTION FINANCING
OPTIONS ARE AVAILABLE
---------------------------------------------------------- Chapter 3:4
Total private financing represents only one end of a continuum of
construction financing options. Total government financing, as
traditionally used in EM's cost-reimbursement management contracts,
represents the opposite end of the continuum. Under total government
financing, contractors are paid as costs are incurred, eliminating
the need to arrange private financing to carry these costs. The
performance risk faced by the contractor is also low because the
payment is based on costs incurred, not for performance of cleanup
services.\2 The government, through EM, bears the bulk of the
performance risk.
In between these two extremes, other financing options exist that
attempt to strike a balance between financing cost and performance
risk. On the basis of reviews of literature and discussions with
government and private-sector officials involved with privatization
financing, we identified several other financing options. These
options are by no means inclusive of all of the possible financing
options available to EM, but they reflect a range of options that
might be considered and the trade-off between financing costs and
performance risk borne by the government. These options include
government guarantee of private-sector debt, a performance-based
partial-payment plan, and progress payments.
--------------------
\2 Total government-financed contracts--such as DOE's traditional
cost-reimbursement contracts--may include an award fee that is
dependent on the performance of the contractor. However, typical
award fees in DOE's cost-reimbursement contracts represent a small
percentage of the total value of any single contract. According to
DOE officials, the total award fees paid by DOE each year amount to
tens of millions of dollars.
GOVERNMENT GUARANTEE OF
DEBT
------------------------------------------------------ Chapter 3:4.0.1
A contractor's construction financing will likely include a great
deal of private debt financing. The total amount of debt financing
is expected to account for about 70 percent or more of the total
financing required. Lenders will charge an interest rate on the debt
on the basis of their perceived risk of losing the money loaned to
the contractor for construction. The higher the perceived risk that
the contractor will not be successful and default on the loan
repayment, the higher the interest rate charged for the debt
financing, assuming private debt financing is available at all.
However, if the government were to guarantee the lenders that they
would not lose their money through default, then the interest rate
charged and the contractor's financing costs would be lowered. The
government could choose to guarantee all or some portion of the total
private debt, which could significantly lower the contractor's
financing costs.
Even with a government guarantee of debt, the contractor would still
face a performance risk; that is, the contractor would not get paid
unless it delivered cleanup services. However, with government
involvement in the financing, the government would also bear a
performance risk it did not face under total private financing. The
government guarantee of debt would put the government in a position
in which it would have to reimburse lenders for any defaults on debt
financing for the project. If the amount of debt is significant, a
100-percent government guarantee could result in high costs to the
government in case of default. Because of the default risk faced by
the government, EM would be required to estimate a subsidy cost of
providing any debt guarantee.\3 This cost must be considered in
addition to the contractor's financing costs when considering this
type of financing option.
--------------------
\3 Federal loan guarantees made on or after October 1, 1991, are
subject to the requirements of the Federal Credit Reform Act, which
includes a requirement to estimate subsidy cost. See chapter 4 for
further discussion of this issue.
PERFORMANCE-BASED
PARTIAL-PAYMENT PLAN
------------------------------------------------------ Chapter 3:4.0.2
Another option that may be available to EM is a partial-payment plan
that is tied to the contractor's performance. Under this option, the
government would pay for a portion of the construction costs as they
are incurred, while the contractor would be required to finance the
balance until it began operations. Then, as in the private financing
option, the government would make payments based on the performance
of cleanup services--such as the amount of waste processed--that
would allow the contractor to recoup its construction costs plus its
financing costs. For example, the government could pay 80 percent of
construction costs as they are incurred while the contractor would be
required to finance 20 percent of the construction costs. With the
government providing an increasing portion of construction costs, the
amount of private financing required would drop and financing costs
could be lowered significantly.
With the performance-based partial-payment plan, the contractor would
still face performance risk to the extent that recouping its portion
of the construction and financing costs still would be dependent on
successful performance. However, as the amount of government
financing increases, the amount of performance risk assumed by the
government also increases. Many variations of this option may be
considered that either increase or decrease the amount of funding the
government provides.
PROGRESS PAYMENTS
------------------------------------------------------ Chapter 3:4.0.3
Progress payments are used throughout the federal government for the
procurement of various types of assets, including capital assets.
Generally, the government uses progress payments to assist a
contractor who will incur significant expenditures prior to the
delivery of products that it will not be able to finance itself. The
government may provide up to 80 percent of the costs as they are
incurred under a contract. The balance is generally paid upon
successful completion of the contract.
EM's privatization projects with large construction costs will cause
contractors to incur significant expenditures prior to the completion
of facilities and the delivery of cleanup services. Under a progress
payment option, the government could pay for a portion of the costs
as they are incurred while the contractor would be required to
finance the balance of its costs. This option is similar to the
performance-based partial-payment plan; however, under the progress
payment option, the contractor would recoup its construction costs
plus its financing costs as the cleanup facility (the asset) was
successfully completed. Payment to the contractor for construction
would not be based on performance over an initial operations period.
Financing costs would be lower because the contractor would not carry
its construction costs over a period of operations.
With the progress payment option, the contractor would still face
performance risk for the delivery of a completed facility that works
as designed. Many variations of this option could be considered that
either increase or decrease the amount of funding the government
provides. Once again, as the amount of government financing
increases, the amount of government funding at risk to performance
increases.
ADVANCED MIXED WASTE TREATMENT
PROJECT SERVES AS MODEL FOR
ANALYZING CONSTRUCTION
FINANCING OPTIONS
---------------------------------------------------------- Chapter 3:5
In order to evaluate the impact of other construction financing
options on financing costs, we reviewed the financing schedule of
EM's privatization contract with British Nuclear Fuels Limited, Inc.,
to build the Advanced Mixed Waste Treatment Project in Idaho. The
contract, signed in December 1996, is one of the few privatization
contracts that has been signed whose construction costs are financed
by the private sector. Assuming that construction costs of $244.6
million, in 1998 dollars, would be the same for each financing
option, we analyzed the difference in financing costs for the five
financing options. (For further detail and discussion of the
analysis conducted and the impact on results of using different
assumptions, see app. II.)
GOVERNMENT FINANCING
INVOLVES A TRADE-OFF
BETWEEN LOWER FINANCING
COSTS AND INCREASED
PERFORMANCE RISK TO THE
GOVERNMENT
------------------------------------------------------ Chapter 3:5.0.1
Using the Advanced Mixed Waste Treatment Project as a model, total
private financing represents the highest financing cost--$137.9
million--for construction financing. As the amount of government
involvement in financing increases, the financing costs of the
options decrease. With a 100-percent government guarantee of debt,
the contractor's financing costs are $104.1 million. Under a
performance-based partial-payment plan that assumes government
financing of 80 percent of costs and payment of the balance over the
first 5 years of operations, financing costs are $62.7 million.
Under a progress payment option with the government financing 80
percent of costs until construction is completed, financing costs are
$47.1 million. Finally, with total government financing, no private
financing costs are incurred because contractors are paid as costs
are incurred.\4
While government financing of construction costs would appear to be
the most attractive option, under this approach the government is
assuming a much greater level of performance risk than it would face
under a private financing option. This risk includes the risk that
the facility the government finances will not be completed
successfully or that the facility will experience significant cost
growth. The potential costs associated with these risks could
offset--or more than offset--any potential benefits of lower-cost
government financing. On the basis of DOE's past experience with
major government financed projects, including EM's projects, these
risks are real. For example, we found that between 1980 and 1996, 31
of DOE's 80 major system acquisitions were terminated prior to
completion after the government had expended over $10 billion, in
part, as the result of weaknesses in DOE's contractor management. In
addition, for the 15 projects that were completed, final costs
exceeded original estimates by an average of 63 percent. However, it
is difficult to determine how much of the costs attributable to these
risks could have been reduced through the use of more private
financing.
We found that termination and/or cost growth of projects is the
result of a variety of factors--some of which may be affected by the
choice of financing.\5 For example, the risk of cost growth because
of a flawed system of incentives for contractors may be reduced by
private financing that provides better incentives to perform.
However, other factors contributing to risk may not be dependent on
the financing choice. For example, changes in work scope could
result in terminations or cost growth under any financing approach.
As a result, it is difficult to quantify the degree of performance
risk borne by the government as government involvement in financing
increases. This uncertainty is represented in figure 3.1 by a
potential range of additional performance risk assumed by the
government with increased levels of government financing.
Figure 3.1: Relationship
Between Financing Approaches
and the Amount of Performance
Risk Assumed by the Federal
Government
(See figure in printed
edition.)
--------------------
\4 Although there is no financing cost under the total government
financing scenario we examined, a cost-reimbursement contract
typically has a fee or profit component of less than 5 percent of the
total costs covered in the contract. Hence, these contracts are
often referred to as "cost plus" contracts. If the Advanced Mixed
Waste Treatment Project were constructed under this type of contract,
the government could expect to pay fees of about 1.41 percent, or
$3.5 million in 1998 dollars.
\5 In our report on major system acquisitions, we found that four key
factors underlie cost growth: unclear or changing missions,
incremental funding of projects, a flawed system of incentives for
both DOE's employees and contractors, and a lack of sufficient DOE
personnel with the appropriate skills to effectively oversee
contractors' operations. Department of Energy: Opportunity to
Improve Management of Major System Acquisitions (GAO/RCED-97-17, Nov.
26, 1996).
CONSIDERATION OF THE COST
OF PERFORMANCE RISK FOR
OTHER FINANCING OPTIONS
------------------------------------------------------ Chapter 3:5.0.2
The options that lie between total private financing and total
government financing attempt to strike a balance in the trade-off
between the cost of financing and the cost of added performance risk.
The cost of added performance risk to the government is difficult to
quantify, but it must be considered in weighing any decision to
reduce private-sector risk (thereby increasing government risk) by
lowering financing costs.
The consideration of added risk costs has been recognized in the
government's policy on the guarantee of debt. If EM were to pursue
an option whereby it would guarantee debt, EM would have to estimate
and obtain funding for the subsidy cost of providing that debt
guarantee. Thus, assuming a 100-percent debt guarantee, costs would
include construction costs ($244.6 million), contractor financing
costs ($104.1 million), and an estimated subsidy cost. That subsidy
cost would largely consist of an estimate of the risk that a
contractor might default on its debt obligations. While the estimate
of the subsidy cost is difficult, the risk of default could be high
for a complex facility that typifies some of EM's cleanup projects.
If the subsidy cost estimate is higher than $33.8 million, then
according to our model, this option would be more expensive than
total private financing.
The consideration of added risk costs must also be recognized for
other financing alternatives to private financing. Using our model,
under a performance-based partial-payment plan whereby EM pays 80
percent of construction costs, EM has placed at risk $195.7 million
in payments (80 percent of the $244.6 million in construction costs)
over the 5 years of construction. This risk must be weighed against
the 20 percent of construction costs plus the financing costs that
the private contractor has at stake over the construction period and
an initial period of operations. If the private contractor does not
perform, it will lose its $48.9 million in construction costs (20
percent of the $244.6 million in construction costs) plus as much as
$62.7 million in finance costs. In weighing this type of option, EM
will have to consider whether the amount of private-sector investment
at risk is enough to ensure that the contractor is motivated to
deliver a facility that works as designed without significant cost
growth.
The consideration of the cost of added risk under a progress payment
option is similar to the partial payment aspect of the option
discussed above. If the facility does not work, EM may not regain
its $195.7 million. However, under a progress payment option, the
contractor would be paid for its construction costs and financing
costs after the facility is successfully completed, thereby avoiding
financing costs over the operations period. Thus, the government is
assuming some added risk that the facility may not operate as
promised over the first 5 years of operations. Unlike the
performance-based option, the contractor will have no investment at
stake whose recoupment is dependent upon successful operations. In
considering this type of option, EM will have to consider whether the
payback (or amortization) of the contractor's costs over the first 5
years of operations is necessary to ensure that the contractor has
delivered an effective plant. An initial testing phase after
construction may be sufficient, depending on the size and complexity
of the project.
OTHER FACTORS AFFECT FINANCING
DECISIONS
---------------------------------------------------------- Chapter 3:6
The choice of financing options is affected by other factors that
affect total costs and financing decisions. As government
involvement in financing increases, the government assumes more of an
ownership role and has to exercise more oversight, an area in which
DOE has not enjoyed success. More importantly, the actual terms of
performance in the contract will dictate what performance risk is
eventually assumed by the contractor and the government.
INCREASING USE OF
GOVERNMENT FINANCING MAY
AFFECT OWNERSHIP AND
OVERSIGHT
------------------------------------------------------ Chapter 3:6.0.1
With an increased use of government financing, the issues of
government ownership and oversight become important considerations.
As the government provides more financing of construction costs, it
becomes more likely that EM will be the owner of the facility instead
of the contractor. However, along with the benefits of government
ownership, EM must consider the negative consequences of ownership,
particularly the demands of an increased oversight role.
Financing construction costs could put the government in a position
of ownership, especially if it is providing the majority of the
funding. This ownership is a positive benefit of government
financing that addresses monopoly concerns about private ownership of
cleanup facilities. For example, if the private sector owns a
facility whose construction costs are paid for after an initial
period of operations, it could place the private sector in a
monopolistic position for the remainder of the potential operating
period. The government may be at a disadvantage in negotiating
prices for waste treatment in the future because there will be no
other facilities available to compete. However, the government may
be able to alleviate monopoly concerns by negotiating long-term
operating agreements or having the contract option to take title to
the facility.
Given EM's acknowledged poor history of oversight, government
ownership could also be viewed as a negative consequence of
government financing. If EM begins to make payments prior to
performance, it will need to assure itself that the contractor is
making satisfactory progress. However, EM does not have a history of
successful contractor oversight. The private sector views increased
government oversight as meddlesome, inefficient, costly, and directly
counter to the concept of allowing the private sector to decide how
to best provide cleanup services.
TERMS OF PERFORMANCE ARE
AN IMPORTANT
CONSIDERATION THAT
AFFECTS RISKS AND COSTS
------------------------------------------------------ Chapter 3:6.0.2
Our discussion of construction financing options has focused on the
level of risk that is transferred between the government and the
private sector as the level of financing provided by each party
changes. However, it is important to point out that the mix of
financing provided by the government and the private sector has no
bearing on the actual terms of performance that are agreed to in a
contract. As noted earlier in our discussion of contracting, risks
must be identified and addressed in the contract so that each party's
responsibilities are clearly defined. The government could face more
risk and incur more costs from a contract that is totally privately
financed if the terms of the contract give the contractor less
responsibility for risks compared to another contract that may have
government financing.
AGENCY COMMENTS AND OUR
EVALUATION
---------------------------------------------------------- Chapter 3:7
DOE agreed with our statement that while government financing appears
less costly, the greater performance risk the government assumes when
it finances a project, and the potential costs associated with this
greater risk, could offset any apparent advantage gained by using
lower-cost government financing. However, DOE felt that we should
have attempted to compensate for these potential increases in costs
in the model we used to estimate the impact of financing
alternatives. In earlier meetings with DOE officials, they had
suggested performing a sensitivity analysis that would vary the
construction costs to reflect various levels of cost growth,
specifically 20, 40 and 60 percent.
We considered performing the sensitivity analysis DOE suggested;
however, we decided not to do so because we did not have a factual
basis for assigning levels of cost growth to all of the various
financing alternatives we analyzed. If not properly managed, each of
the alternatives we analyzed, including the private finance option,
could experience cost growth. However, we could not locate any data
that would identify how much cost growth might be associated with one
financing option versus another. Applying the same cost growth to
all of the options would not change the relative results, only the
total costs. To compensate, we emphasized throughout the report that
cost growth was a possibility as the government took on more
performance risk and cited what evidence we had in terms of
independent studies and GAO reports to indicate how large this growth
had been under DOE's existing contracts.
USE OF ALTERNATIVE FINANCING
STRUCTURES COULD CHANGE HOW EM'S
PRIVATIZATION PROJECTS ARE SCORED
IN THE FEDERAL BUDGET
============================================================ Chapter 4
Because of budget limitations or "caps" instituted to help balance
the federal budget, all budget appropriations and spending for
discretionary programs,\1 such as EM's privatization program, must be
measured or "scored" to ensure that the caps are not exceeded.
Federal agencies may acquire or use long-term assets constructed to
meet the government's needs, such as the waste treatment facilities
EM needs, in several ways. Each of those arrangements may be scored
differently. Which arrangement and, hence, which method of scoring
is most appropriate may change depending on how the asset is
financed, whether the government takes ownership of the asset, and
how much risk the government assumes for the cost of construction.
--------------------
\1 Discretionary programs receive budgetary resources provided in
annual appropriations acts, as opposed to mandatory spending
authority (such as that for entitlements and the food stamp program),
which is provided by other laws.
BUDGET SCORING COULD DETERMINE
WHAT PROJECTS CAN BE PURSUED
---------------------------------------------------------- Chapter 4:1
Under the Budget Enforcement Act of 1990, as amended, discretionary
spending is constrained by caps or strict dollar limits both on new
budget authority and budget outlays.\2 To ensure that caps are not
exceeded, the scoring rules contained in the conference report
accompanying the Budget Enforcement Act of 1990, as amended, and
published in the Office of Management and Budget's (OMB) Circular
A-11 are used to determine when budget authority and budget outlays
are scored for discretionary spending proposals--including spending
for capital assets. To stay within the caps, budget authority and
the resulting outlays are limited for all programs. The way
transactions between EM and its privatization contractors are
structured affects how they are scored and, because of the budget
caps, has consequences not only for EM but also for all the other
programs and activities funded by the committees that provide EM's
appropriations.
--------------------
\2 Budget authority is the authority provided by law to enter into
financial obligations that will result in immediate or future outlays
of federal funds. Outlays are the actual issuance of checks,
disbursements of cash, or electronic transfers of funds made to
liquidate a federal obligation.
THERE ARE SEVERAL DIFFERENT
OPTIONS FOR SCORING THE
ACQUISITION OR USE OF CAPITAL
ASSETS
---------------------------------------------------------- Chapter 4:2
There are several ways the federal government can acquire capital
assets or the use of capital assets, such as an office building or
waste treatment facility, that are being constructed for its use.
The most direct way is to simply purchase the asset outright, taking
full ownership of it. In that case, budget authority for the full
cost of the purchase would be scored in the year the budget authority
is first made available, and budget outlays would be scored as
payments are made to the contractor during construction.
Alternatively, agencies may choose not to purchase the asset itself
(for example, a waste treatment plant) but merely the services
connected with the asset (for example, waste treatment services).
For such a service contract, the agency would need budget authority
in each year equal to its legal obligations under the contract,
including cancellation costs. In a case in which services will not
be delivered until the construction of a facility is complete,
outlays would not be scored during the construction period; instead,
they would be scored as services are delivered.
In addition to outright purchase of an asset or purchase of services,
the agency may choose to lease the asset from the private contractor.
Under the budget scoring guidelines, the government may enter into
three types of leases with private vendors--operating leases,
lease-purchases, and capital leases. Operating leases may be used to
contract for assets such as general-purpose office space. In an
operating lease, the facility or equipment is not built to unique
government specifications, there is a private-sector market for the
asset, and the present value of the government's lease payments does
not exceed 90 percent of the asset's fair market value at the
beginning of the lease, among other criteria. For an operating
lease, the agency would need budget authority and have outlays in
each year equal to the payments due to the contractor under the
lease.
Transactions that do not meet all of the criteria of an operating
lease are considered either lease-purchases or capital leases. In a
lease-purchase transaction, ownership of the facility or other assets
transfers to the government at or shortly after the end of the lease.
If ownership does not transfer, the transaction is a capital lease.
For a lease-purchase arrangement, the government's risk\3 is assessed
against criteria that indicate the government's acceptance of risk
such as whether (1) the government provides financing, (2) the
government guarantees third-party financing, (3) there is no
private-sector market for the assets, (4) the asset is built to
unique specifications, (5) the risks of ownership do not remain with
the contractor, and (6) the project is constructed on government
land. For a lease-purchase without substantial government risk, the
agency would need budget authority in the first year equal to the
present value of its obligations under the lease, and outlays would
be scored over the lease term. The government's obligations would
include the contractor's capital investment and termination or
cancellation costs. If the government does have substantial risk,
budget authority would be scored the same way as noted above, but
outlays would be scored during the construction period in the same
proportion as the contractor's costs are incurred. Capital leases
are scored in the same way as a lease-purchase without substantial
government risk.
Finally, if an agency were to offer a federal government guarantee of
some or all of a contractor's debt financing, the subsidy cost of the
guarantee would be scored. The agency would need specific
legislative authority to offer a government loan guarantee. If the
authority were granted, the agency would have to estimate the subsidy
cost of the loan guarantee, which would be based on the risk of
default or nonpayment of the loans, among other factors. Estimating
the subsidy cost is a very complex process and is subject to review
by OMB and the Congressional Budget Office. The agency would need
budget authority for the full net present value of the subsidy cost
before it could make the guarantee. Outlays of the subsidy cost
would occur over the same period and in the same proportion as the
lender disbursed the loan to the contractor. That is, if all of the
loan money were disbursed in the first year, all of the subsidy cost
would be outlayed in the first year as well. If the loan were
disbursed over a period of several years, the outlays would be spread
over the same period.\4
--------------------
\3 Although Circular A-11 is written from the perspective of private
risk, this report focuses on the government's risk and is written
from that perspective.
\4 See Credit Reform: Greater Effort Needed to Overcome Persistent
Cost Estimation Problems (GAO/AIMD-98-14, Mar. 30, 1998), pp.
36-42, for a fuller discussion of loan guarantees under the Credit
Reform Act.
CHANGING HOW EM'S PRIVATIZATION
PROJECTS ARE FINANCED COULD
AFFECT THE INTERPRETATION OF
THE SCORING GUIDELINES
---------------------------------------------------------- Chapter 4:3
Currently, OMB scores EM's privatization projects as service
contracts. Under this practice, EM must have enough budget authority
each year during the life of the contract to (1) pay off its
liability to the contractor if, for example, the project is canceled,
and (2) pay for treated waste once facilities begin operations. The
contractor is to provide all of the financing for constructing the
necessary facilities and equipment to treat EM waste. EM does not
intend to acquire title to the facilities that would be constructed
by its privatization contractors, even when those facilities are
built on federal land and are constructed to provide services
strictly for the government. Under OMB's current scoring, no outlays
would be scored until construction of a project is completed and
waste processing begins. Outlays would then be scored from the
privatization account as the capital cost of the project is amortized
or repaid over the first few years of operations.\5 Therefore, while
the impact on outlays in the budget is minimized in the early years
of the privatization program under this option, it will increase
outlays dramatically in later years as these projects come on-line.
--------------------
\5 Under the current scoring method and all of the options we
analyzed, EM would need budget authority and would have outlays from
its annual operating funding to pay for the amounts of waste treated
to contract specifications.
LOAN GUARANTEE SCENARIO
------------------------------------------------------ Chapter 4:3.0.1
Government loan guarantees are usually offered only when the borrower
or the project is too risky for private lenders. Because many of the
projects proposed for privatization are technically risky--that is,
they involve the use of innovative technologies that must be modified
to meet EM's needs--the subsidy cost of a loan guarantee for
privatization projects could be substantial. For this option, EM
also would need additional budget authority upfront for the subsidy
cost. Outlays of the subsidy cost would occur over the construction
period as the loan is disbursed by the private lender to the
contractor.
If EM were given authority to provide a loan guarantee for the
construction of a contractor-owned facility, OMB may decide to
continue to score the project's total capital costs as a service
contract. Alternatively, the capital costs might be scored as a
capital lease. In that case, budget authority and outlays would
occur sooner than under the current service contract scoring method.
PERFORMANCE-BASED
PARTIAL-PAYMENT SCENARIO
------------------------------------------------------ Chapter 4:3.0.2
If EM used a performance-based partial-payment plan, scorekeeping
guidelines could be interpreted to require EM to have budget
authority up front for the net present value of the government's
share of costs.\6 Outlays would occur during the construction period
equal to the amount of incurred costs for which EM reimburses the
contractor and during the initial period of performance for the
remainder of the construction costs. For this option, which might be
scored as a capital lease or a lease-purchase (if it is judged that
EM has effective ownership), the timing of budget authority and
outlays would change, occurring sooner than under the current service
contract scoring scenario.
Under this scenario, the greater degree of financial investment and
risk that EM would incur could make government ownership of the
facility more attractive than only contracting for the services of
the completed facility. In that event, EM could choose to structure
the contract so that it would acquire ownership of the facility at or
near the end of the initial performance period. The initial
performance period would provide EM assurance that the facility works
and would give the contractor time to recoup all of its investment.
However, in that case, the transaction could be deemed a
lease-purchase with substantial government risk under the budget
scoring guidelines. As a result, the timing of budget authority and
outlays would change, occurring sooner than under the current service
contract scoring scenario.
--------------------
\6 As described in the previous section, EM would only be providing a
portion of the capital financing during construction. Thus, the
government's share of costs would most likely include interest to be
paid on the portion of construction costs being financed by the
contractor, even if recovery of the contractor's financing costs
would only be earned through satisfactory performance.
PROGRESS PAYMENT SCENARIO
------------------------------------------------------ Chapter 4:3.0.3
If the construction were financed using progress payments, the
transaction might be scored as a capital lease or a lease-purchase
(if it is judged that EM has effective ownership). In that event, EM
would need budget authority equal to the net present value of the
government's share of the costs plus a rate of return earned on the
held-back portion. Outlays would occur during construction equal to
EM's share of the portion of costs incurred by the contractor and for
the lump-sum payment of the held-back portion of the construction
costs once the contractor's work had been accepted.\7 For this
financing option, the timing of budget authority and outlays would
change, occurring sooner than under the current service contract
scoring scenario.
In this scenario, EM would again be making a substantial financial
investment in the facility and incurring a greater degree of risk
than it would if the contractor privately financed the construction
of the facility. In that case, EM might decide to include an option
in the contract allowing it to take title to the completed facility,
and the transaction might be considered a lease-purchase under the
budget scoring guidelines. In that case, EM would need budget
authority equal to the full net present value of the project,
regardless of what proportion of the costs were paid to the
contractor in progress payments and what proportion are held back for
lump-sum payment when the contractor's work has been accepted.
--------------------
\7 The criteria for acceptance of the facility by the government
would be negotiated in the contract and could allow for an initial
period of performance sufficient to ensure that the facility will
operate as promised.
FULL-GOVERNMENT-FINANCING
SCENARIO
------------------------------------------------------ Chapter 4:3.0.4
Finally, if EM fully finances the projects, it would need budget
authority to cover the full amount of costs and fee or profit owed to
the contractor for the construction of the facility.\8 Outlays would
be incurred for the amount of costs incurred by the contractor and
any fee or profit earned in each fiscal year. In that case, the
government would bear the financial risk and, logically, may want to
have ownership of the facility. The contractor would be reimbursed
for all allowable costs, including costs for the design and testing
of the facility and equipment, during the construction period. For
this option, budget authority needs could be larger in the first
years of the project than under EM's current privatization approach,
and once again, outlays would occur sooner.
--------------------
\8 Although OMB's guidance requires agencies to request full funding
before beginning a construction project, the Congress has
historically provided only incremental funding (that is, an amount to
meet a project's estimated needs for only 1 fiscal year) for DOE's
projects.
OWNERSHIP AND DEGREE OF
GOVERNMENT RISK ARE KEY FACTORS
FOR SCORING
---------------------------------------------------------- Chapter 4:4
Under the budget scoring guidelines, how EM's privatization projects
are scored depends on two key factors: who owns the facility and, if
the government will have ownership, what degree of risk the
government assumes. However, several factors may cause EM to decide
to own the facility itself. Some projects may require EM to make a
large investment of government funding in the construction of a
facility. In addition, privatization contracts are expected to
contain clauses, such as termination for convenience and idle
facility payments, to protect the contractor from loss if the project
is canceled or delayed by the government. For example, a termination
for convenience clause provides the government the option of
canceling the project if EM cannot get sufficient funding to proceed
in any fiscal year. The government may also be liable for payments
for idle facilities if the contractor's facility is ready to operate
and EM fails to deliver waste to be treated.
In such circumstances, EM may have to outlay a large proportion of
the construction costs whether or not it receives waste treatment
services, and it may be in the government's interest to also take
ownership of the facility. In that case, the scoring rules
pertaining to outright ownership or lease-purchases would apply.
Under other circumstances, such as if total private financing has the
hoped-for effect of lowering the total cost and risk, pursuing
service contracts may be the best decision. These factors, in
addition to scoring implications, will need to be considered in
deciding whether ownership of a capital asset is in the best interest
of the government.
BUDGET SCORING PRESSURES MAY
CAUSE FEDERAL AGENCIES TO MAKE
INEFFICIENT ASSET ACQUISITION
DECISIONS
---------------------------------------------------------- Chapter 4:5
In general, as the financial commitment of the government decreases
(that is, moves further away from purchase), the amount of budget
authority and outlays that must be scored up front also decreases.
We found that this situation may tempt agencies to move away from
ownership when caps are very restrictive and to choose arrangements
in which budget authority and outlays are not scored all at once or
as soon.\9 In some cases, we found that these decisions resulted in
agencies spending more than they would have if they had purchased the
assets outright. Budget scoring does not affect the total cost of
the projects but does change when budget authority is needed and when
outlays occur. Under all of the alternative financing scenarios we
analyzed, except possibly full-government financing, scorekeeping
guidelines could result in EM needing more budget authority earlier
in the projects and incurring outlays sooner than under OMB's current
method of scoring privatization projects as service contracts. EM
officials have noted that one advantage of privately financing
projects is that it allows EM to defer budget outlays to future time
periods. While this may be true, EM's decisions on how to structure
privatization contracts need to consider the other factors we have
discussed previously--contract type, financing method, risk
allocation, and long-term cost--as well as the budget scoring
implications of the contracts.
--------------------
\9 Budget Issues: Budgeting for Federal Capital (GAO/AIMD-97-5, Nov.
12, 1996).
AGENCY COMMENTS AND OUR
EVALUATION
---------------------------------------------------------- Chapter 4:6
DOE expressed the view that individual projects have different
financing requirements that are not directly addressed by the current
budget scoring guidelines of OMB Circular A-11. They also expressed
the view that there is considerable flexibility in the scoring rules.
We agree that the scoring guidelines do not directly address the
unique projects that DOE is considering. We specifically state in
all of our discussions of scoring that the scoring rules have to be
interpreted for DOE's projects.
CONCLUSIONS
============================================================ Chapter 5
Unsatisfied with its management contractors, EM has attempted to
improve the cost and schedule performance of the cleanup program
through the adoption of its privatization approach. In theory, EM's
privatization contractors have a greater incentive to perform under a
fixed-price contract than in the traditional cost-reimbursement
environment, under which most cleanups have been performed. While we
did find examples when the use of fixed-price contracting produced
positive results, simply entering into a fixed-price contract is no
guarantee of success. If fixed-price contracts are used in
situations when they are not appropriate--for example, where waste is
inadequately characterized--the cost and schedule performance of the
contractor can be worse than under a cost-reimbursement contract.
Private contractor financing, which has the potential to improve cost
and schedule performance, comes at a significant increase in
financing costs. However, it would be incorrect to look at this
difference and simply conclude that traditional cost-reimbursement
government financing is cheaper. The apparent difference in cost
reflects the different amount of risk the government is bearing.
Moreover, if the performance under the cost-reimbursement type of
financing is as poor as past history would suggest, the difference,
or "savings," observed in our analysis could easily be consumed by
cost overruns.
With respect to scoring, how these projects are scored will depend on
how certain key aspects of the scoring rules are interpreted. For
example, if ownership is viewed as the critical variable and the
government does not own the final facility, any approach we have
analyzed could be scored as a capital lease. However, if the
government assumes ownership upon completion of an initial
performance period, then a lease-purchase would appear more
appropriate. Use of a government loan guarantee would require the
estimation of the subsidy cost, for which additional budget authority
would be needed, and could add significantly to the total budget
authority required for privatization projects.
In the end, it is not simply a choice between traditional
cost-reimbursement contracting and EM's new privatization approach.
As our analysis shows, a complex matrix of decision factors needs to
be considered when deciding how to contract for and finance a
cleanup. Among the factors that need to be weighed are the
following: (1) What waste needs to be cleaned up and how well is the
waste characterized? (2) How much competition is there is among
firms with the necessary cleanup expertise? (3) What financing
options are available in the private sector? (4) What risks are
associated with the cleanup and who is best prepared to bear them?
(5) How well equipped is DOE's staff to design and oversee a cleanup
contract? Once a contract type and financing method are chosen, DOE
and the contractor would need to carefully develop a contract that
clearly defines each party's roles and accountability through
provisions that allocate project risk between the parties, define
DOE's oversight role, and identify appropriate measures against which
the contractor's performance will be judged. Ideally, selection of
the appropriate type of contract and method of financing for each
project would be made on the basis of what will provide EM with the
best chance of successfully completing its cleanup goals at the
lowest total cost.
ALTERNATIVE CONTRACT TYPES USED BY
DOE'S ENVIRONMENTAL MANAGEMENT
PROGRAM FOR CLEANUP PROJECTS
=========================================================== Appendix I
Although the Department of Energy (DOE) has traditionally performed
its work through management contractors using cost-reimbursement
contracts, the Office of Environmental Management (EM) has used a
variety of contract types for purchasing cleanup services, including
fixed-price and cost-reimbursement variants. In general, fixed-price
contracts provide a fixed payment regardless of the actual costs
incurred by the vendor. Cost-reimbursement contracts, on the other
hand, generally repay the vendor for all allowable costs incurred
regardless of what is accomplished. The following table provides
some of the key features of the various contract types used by EM,
defines the circumstances under which they are used, and identifies
the cleanup projects we reviewed that employ each contract type or
combination of contract types.
Table I.1
Major Features and Types of Contracts
That EM Has Used for Environmental
Cleanup Projects
EM projects using
Type of Major features of Circumstances when contract contract type
contract contract type type is generally used (location)
---------- ------------------ ---------------------------- ------------------
Fixed-price contracts
--------------------------------------------------------------------------------
Firm Price is set at Work scope is well-defined M-Area Mixed Waste
fixed- contract award by and no major changes are Tank Remediation
price competitive prices expected (Savannah River)
or negotiation
Uncertainties are Environmental
Price is not quantifiable Management/Waste
adjusted based on Management
contractor's costs Best for purchase of Disposal Cell (Oak
during commercial products Ridge)\a
performance
Scintillation
Low flexibility Cocktail Bulking
for government (Oak Ridge)
because changes
must be West End Treatment
negotiated Facility--Phase I,
original contract
Low cost risk for (Oak Ridge)
government as long
as scope does not TMI-2 Turnkey
change; high cost Interim Storage
risk for vendor System Facility
(Idaho)\b
Low performance
risk for Advanced Mixed
government as long Waste Treatment
as scope does not Project--Phase I
change; high licensing,
performance risk permitting, and
for vendor preliminary design
(Idaho)
Tank Waste
Remediation
System--Phase I
conceptual design
(Hanford)
Fixed- Price quoted on a Work scope can be adjusted Low-Level Mixed
price with per-unit basis in within stated limits to fit Waste Thermal and
fixed per- this variant of government priorities and Non-Thermal
unit firm-fixed-price funding availability Treatment
pricing (Hanford)
Allows government Minimum units of work are
some flexibility known (e.g., X barrels of Tri-Butyl
by stating work in waste are in storage ready Phosphate
units, usually to be processed) Treatment
with minimum and (Hanford)
maximum amounts If vendor cannot use
guaranteed during facilities for other Tank Waste
a set contract clients, contract may Remediation
period provide for idle facility System--waste
payments treatment phase
Low cost risk for (Hanford)
government but
must pay for Laundry Services
minimum quantity; (Hanford)
high cost risk for
vendor Contaminated
Laundry
Low performance Services (Idaho)
risk for
government; high Low-Level Waste
performance risk Treatment (Idaho)
for vendor
Transuranic Waste
Treatment Project
(Oak Ridge)\a
Broad Spectrum
Low-Level Mixed
Waste Treatment
(Oak Ridge)\a
Spent Nuclear Fuel
Dry Transfer and
Storage (Idaho)\a
Low-Level
Radioactive Waste
Treatment (Oak
Ridge)
Fixed- Price adjusted up Work scope is well-defined East Tennessee
price with or down using and no major changes are Technology Park
economic agreed-upon expected or likely Three Building
price criteria such as a Decontamination
adjustment labor or material There is serious doubt about and
cost index market conditions, e.g., Decommissioning
large potential fluctuations (D&D) Project (Oak
Low flexibility in the costs of key Ridge)
for government components such as materials
without or labor Advanced Mixed
renegotiating work Waste Treatment
scope and cost Component costs covered in Project--Phase III
the price adjustment operations and
Low cost risk for provision are not under the D&D--treatment of
government; high vendor's control but changes first 25,000 cubic
cost risk for cannot be estimated with a meters of waste
vendor except for high degree of accuracy (Idaho)
cost component(s)
covered in the Contract covers an extended
adjustment performance period, e.g.,
provision several years
Low performance
risk for
government; high
performance risk
for vendor
Fixed- Pricing Work scope is well-defined \St. Louis North
price with arrangement County Site,
incentives negotiated places Objectives in addition to Formerly Utilized
and firm an appropriate cost control are deemed Sites Remedial
target share of risk on important, e.g., workplace Action Program
price vendor safety, waste minimization,
etc.
Low flexibility
for government Relates incentive fee
because price and (profit) to cost control and
targets must be may include incentives for
renegotiated if performance on critical
work scope aspects of work
changes
Cost control incentives
More cost risk for required when performance
government than incentives are used to
under firm-fixed- preclude reward for
price; vendor performance if cost
assumes some cost outweighs its value
risk because fee
is tied to cost Contractor must have an
control acceptable accounting system
More performance
risk for
government than
under firm-fixed-
price because
government shares
in cost overruns;
less performance
risk for vendor
Fixed- Price for initial A fair firm-fixed price can Advanced Mixed
price with performance period be negotiated for an initial Waste Treatment
prospectiv is fixed when period but not for the Project--Phase III
e price contract is entire contract period operations and
redetermin negotiated D&D--treatment
ation A relatively brief period of after first 25,000
Price is performance will provide the cubic meters of
subsequently pricing information needed waste is complete
adjusted at to set price for the and every 5 years
stated remainder of the contract thereafter on a
periods during the 20-year contract
life of the Suitable for a contract with (Idaho)
contract in a lengthy performance period
anticipation of (e.g., 10 to 20 years)
future conditions
affecting the cost
of performance
Other features are
the same as firm-
fixed-price except
the government
bears more cost
risk because the
final cost is not
set at contract
award
Fixed- Price for a unit Work scope in terms of the Maywood Site
price of work is known number of units to be done Cleanup, Formerly
using a but total price of is not known with certainty Utilized Sites
fixed unit work is not known Remedial Action
rate Not enough information is Program
More flexible for known to set minimum and
government than maximum levels of work scope New Brunswick Soil
fixed-price with Sorting
per-unit pricing, Demonstration,
but vendor has no Formerly Utilized
incentive to Sites Remedial
minimize the Action Program
amount of work
done
Higher cost risk
for government
than other forms
of fixed-price
contracts; lower
cost risk for
vendor
Low performance
risk for
government; higher
performance risk
for vendor
Cost-reimbursement contracts
--------------------------------------------------------------------------------
Cost and Cost contract Work scope cannot be West End Treatment
cost- includes no fee precisely defined Facility Phase I-
sharing (profit) portion, -actual results
contracts but the vendor is Cost contracts are usually after equitable
reimbursed for all used for research and adjustment (Oak
allowable costs development work done by Ridge)\c
incurred nonprofit organizations such
as universities
A cost-sharing
contract includes Cost-sharing contracts can
no fee (profit) be used any time, but the
portion, but vendor expects other
vendor is compensating benefits from
reimbursed for participation (e.g., follow-
only negotiated on contracts, patentable
portion of costs process, etc.)
incurred
Contractor must have an
Increases acceptable accounting system
government
flexibility
Increases cost
risk for
government;
lessens vendor's
cost risk
Increases
performance risk
for government;
minimal
performance risk
for vendor
Cost- Target cost and Work scope can be reasonably Management and
plus- incentive fees are well-defined, but Integrating
incentive- negotiated for a significant uncertainties contracts for EM
fee specific scope of remain site management
work; incentive is
adjusted based on Performance features subject K-25 Powerhouse
relationship to incentives can be Demolition (Oak
between total objectively measured Ridge)
target cost and
total actual cost Used for development and K-25 Cooling
testing programs and to Towers Demolition
Low flexibility motivate vendor to manage (Oak Ridge)
for government projects more effectively
because changes to Lower East Fork
work scope require When incentive fee includes Poplar Creek
renegotiation of a "negative" portion, vendor Operable Unit
target cost and may not recover all costs Cleanup (Oak
incentive fees incurred Ridge)
High cost risk for Fee pool for fixed and
government; some performance incentives is
cost risk for negotiated; performance
vendor because incentives are assigned a
vendor shares in negotiated value from the
cost overruns relevant fee pool
High performance Contractor must have an
risk for acceptable accounting system
government; low
performance risk
for vendor
Cost control
incentive required
but additional
incentives can be
added
Cost- All allowable Work scope cannot be Management and
plus- costs are precisely defined and/or is Operating contract
award-fee reimbursed subject to significant, for DOE sites
frequent changes\d
Maximum Kerr Hollow Quarry
flexibility for Changes to work scope may Cleanup (Oak
government to require renegotiation if Ridge)
respond to funding they will impact the
and/or priority vendor's ability to meet
changes during criteria for earning award
performance fee
period
Conditions beyond the
High cost risk for control of the vendor are
government; low expected to have a major
for vendor impact on the vendor's
ability to perform
High performance
risk for Performance cannot be
government; low objectively measured and/or
for vendor noncost considerations are
of high priority (e.g.,
Award fee is safety in nuclear
subjectively operations)
determined by
government and is Contractor must have an
intended to acceptable accounting system
motivate the
vendor for
excellent
performance
--------------------------------------------------------------------------------
\a Procurement is in progress but final contract award has not yet
been made. Categorization reflects current plans.
\b Contract provides for progress payments.
\c The West End Treatment Facility project was planned as a phased
project. Phase I set a fixed-price payment for each awardee to
design and test a waste treatment system and was intended to result
in multiple contract awards. Under the plan, vendors that
successfully completed Phase I would compete for the Phase II
treatment contract. However, only one contract was awarded in Phase
I, and the vendor winning that contract invested significantly more
money in its treatment process than the amount the contract would
reimburse. According to EM and management contractor officials,
because the vendor had a reasonable expectation that it would also
win the Phase II contract, EM agreed to pay the vendor an equitable
adjustment covering the additional costs the vendor had incurred,
when the second phase procurement was canceled.
\d Some proportion of the tasks covered by a management and operating
contract may be precisely defined and measured.
Source: GAO's analysis of the Federal Acquisition Regulation and
Department of Energy contracts.
A MODEL FOR ANALYZING CONSTRUCTION
FINANCING OPTIONS
========================================================== Appendix II
BACKGROUND ON THE ADVANCED
MIXED WASTE TREATMENT
PROJECT
------------------------------------------------------ Appendix II:0.1
We used the Advanced Mixed Waste Treatment Project to assess the
relative impact of different construction financing options on
financing costs. The Advanced Mixed Waste Treatment Project involves
the construction and operation of a waste treatment facility that
will treat laboratory and processing wastes from DOE's various
facilities. The waste contains hazardous waste constituents and
radioactivity and is therefore classified as "mixed waste." According
to the contract schedule, construction costs will be incurred over 5
years, from 1998 to 2002, with operations beginning in 2003. The
current contract covers operations through the year 2015 and has an
option to extend the contract to process more waste beyond 2015.
The Advanced Mixed Waste Treatment Project will incur $270 million
(in actual dollars) in construction costs over 5 years. Accounting
for the fact that these costs will be incurred over 5 different
years, the present value of these costs is $244.6 million. A
discount rate of 6 percent was used to calculate the present value
(1998 dollars) of the construction costs. Table II.1 shows the
contractor's construction costs in actual dollars for 5 years and the
present value of those costs. Then, for each of the different
financing options we analyzed, the table outlines the yearly and
total government payments (in actual dollars) to reimburse the
contractor's construction and financing costs. Also, the table shows
the total present value (1998 dollars) of these payments for each
option.
Table II.1
Advanced Mixed Waste Treatment Project
Construction and Financing Costs
(Dollars in millions)
Pre
sen
t
val
ue
(PV
)
199
8 Performance
dol -
lar Government based Total
s, Contractor Private debt partial- Progress government
tot construction finance guarantee payment payment financing
als costs option option\a option option option
--- ------------ ------------ ---------- ----------- ---------- ----------
Fin N/A\b 137.9 104.1 62.7 47.1 0.0
an
ci
ng
(P
V)
Con 244.6 244.6 244.6 244.6 244.6 244.6
st
ru
ct
io
n
(P
V)
Actual dollars (not adjusted for inflation) by year
--------------------------------------------------------------------------------
199 13.7 0.0 0.0 10.9 10.9 13.7
8
199 109.0 0.0 0.0 87.2 87.2 109.0
9
200 96.8 0.0 0.0 77.4 77.4 96.8
0
200 41.0 0.0 0.0 32.8 32.8 41.0
1
200 9.5 0.0 0.0 7.6 7.6 9.5
2
200 0.0 100.8 91.9 29.4 128.5 0.0
3
200 0.0 134.5 122.6 39.3 0.0 0.0
4
200 0.0 134.6 122.7 39.3 0.0 0.0
5
200 0.0 134.6 122.7 39.3 0.0 0.0
6
200 0.0 64.9 59.2 18.9 0.0 0.0
7
Actual dollars, totals
--------------------------------------------------------------------------------
Fin N/A 299.4 249.1 112.1 74.4 0.0
an
ci
ng
Con 270.0 270.0 270.0 270.0 270.0 270.0
st
ru
ct
io
n
--------------------------------------------------------------------------------
\a Subsidy costs not shown for this option.
\b N/A = not applicable.
The comparison of financing costs for different options assumes that
the construction costs are the same under all options. It also
assumes that the contracts are openly competed, fixed-price except
for the total government financing option, which is assumed to be a
cost-reimbursement contract. This comparison of financing costs does
not attempt to quantify the increased risk faced by the government as
its involvement in financing increases. Following is a discussion of
each financing option and the assumptions made to estimate the
financing costs.
TOTAL PRIVATE FINANCING
------------------------------------------------------ Appendix II:0.2
The Advanced Mixed Waste Treatment Project contract uses total
private financing of construction, as envisioned under EM's
privatization program. Under this option, construction costs are
incurred and carried by the contractor until construction is complete
and acceptable waste treatment services are provided. After
construction is completed in 2002 and operations begin in 2003, the
government begins to reimburse the contractor for its construction
costs incurred and the financing costs that have accrued. These
payments are fixed and directly tied to the contracted amount of
cleanup services to be provided during the first 5 years of
operations. The contractor will recoup its construction and
financing costs in proportion to the amount of waste it successfully
treats during the first 5 years of operations. The contractor's
expected rate of return for financing construction is 15.76 percent
per year on the balance of the construction costs it carries.\1 The
total financing costs under this option are $299.4 million in actual
dollars and $137.9 million in 1998 dollars.
The costs presented in table II.1 for this option use the information
on timing and amounts of payments given in the Advanced Mixed Waste
Treatment Project contract and assume that the contractor is
successful in treating the amounts of waste in the contract that are
required to pay off its costs in 5 years. However, if the contractor
is behind on its delivery of services, it will take longer for the
contractor to recoup its costs. Moreover, because the contractor
will only be paid a fixed rate for cleanup services, the contractor's
effective rate of return for financing construction will be less than
15.76 percent if it does not deliver the contracted amount of cleanup
services.
--------------------
\1 The financing cost includes all contractor costs above
construction costs, including the contractor's cost of raising money,
taxes, and profit.
GOVERNMENT GUARANTEE OF DEBT
------------------------------------------------------ Appendix II:0.3
A government guarantee of debt option is designed to lower private
financing costs by lowering the interest rate on the debt financing.
Under this option, we assumed the same payment process for the total
private financed option. However, to quantify the impact of a
government guarantee of debt, we assumed, on the basis of the reviews
of finance studies and interviews with financiers for these types of
projects, that the contractor's financing of the Advanced Mixed Waste
Treatment Project would consist of 70 percent debt financing at a 10
percent rate of return and 30 percent equity financing with an
expected return of 29.2 percent. Under these assumptions, the total
rate of return is equal to 15.76 percent, the same rate of return
provided for in the actual Advanced Mixed Waste Treatment Project
contract. On the basis of reviews of finance studies and interviews
with financiers, we assumed that a government guarantee of debt would
provide enough assurance to private lenders to lower their required
rate of return on debt by 3 percentage points--from 10 percent to 7
percent. This represents a rate that is close to the government's
cost of borrowing with some allowance for administration of the debt.
The lower required rate of return on the 70 percent portion of debt
financing would have the effect of lowering the overall rate of
return to 13.66 percent.
Under this set of assumptions, the cost of financing the construction
would be $249.1 million in actual dollars and $104.1 million in 1998
dollars.\2 In 1998 dollars, this is a reduction of $33.8 million
compared to the financing costs of $137.9 million for total private
financing. Different assumptions about some of the key factors
influencing costs could present some different scenarios that could
be considered. For example, if the percentage of debt financing was
greater than 70 percent and other factors remained constant, the
government guarantee of debt would have a larger financing cost
reduction than $33.8 million. Conversely, if the government
guarantee of debt does not reduce the cost of private debt as much
(that is, less than 3 percent) then financing costs will be reduced
by less than $33.8 million.
--------------------
\2 These amounts reflect only those financing costs incurred by the
contractor. The government would face additional subsidy costs in a
debt guarantee financing option.
PERFORMANCE-BASED
PARTIAL-PAYMENT PLAN
------------------------------------------------------ Appendix II:0.4
Under the performance-based partial-payment plan, we assumed the
government would pay 80 percent of the construction costs as they are
incurred while the contractor is responsible for financing the
balance. We assumed that the government would pay for 80 percent of
the construction costs because that percentage represents the maximum
amount of government payments generally allowed for progress
payments. To create a performance incentive similar to the total
private financed option, we assumed for this option that the
contractor would recoup its construction costs plus its finance costs
over the first 5 years of operations using the same payback schedule
outlined in the total private financing option. On the basis of the
reduced amount of contractor financing needed, we assumed that the
contractor would not seek debt financing for the 20 percent in costs
it had to finance. Rather, the contractor would finance the costs
itself with equity and would expect a return comparable to the
expected rate of return on equity for the total private financing
option (29.2 percent). Thus, the contractor's share of construction
costs would grow by 29.2 percent during the 5-year construction cost
period as well as during the 5-year operation period. Under this set
of assumptions, the financing costs would be $112.1 million in actual
dollars and $62.7 million in 1998 dollars.
Several variables could affect the total financing cost for this type
of option. For example, the method by which the contractor finances
the construction costs it is carrying would affect the total
financing costs associated with this option. If the contractor were
to finance some portion of its construction costs with debt, as
opposed to all equity financing, then the financing costs would be
lower. The costs would be lower because the expected rate of return
would be based on a mixture of debt at 10 percent and equity at 29.2
percent instead of all equity at 29.2 percent. In addition, the
portion of construction costs paid by the government will also affect
the financing costs under this option. As the government provides
for a lesser portion of the construction costs (that is, less than 80
percent), the amount of construction costs the contractor has to
finance increases. This scenario could raise total financing costs
because more of the higher-cost contractor financing is required.
PROGRESS PAYMENTS
------------------------------------------------------ Appendix II:0.5
Under a progress payment financing option, the government would pay
80 percent of the construction costs as they are incurred while the
contractor is responsible for financing the balance. We assumed that
the government would pay for 80 percent of the construction costs
because it represents the maximum amount of government payments
generally allowed for progress payments. The sequence of government
payments over the 5-year construction cost period would be the same
as the performance-based partial-payment plan. However, unlike the
performance-based partial-payment option, the balance financed by the
contractor would then be recouped when a working facility was
successfully constructed--not during an initial operation period.
Thus, the balance of cost carried by the contractor, plus its
financing cost, would be paid off in one sum once the facility was
completed.
Like the performance-based option discussed above, we assumed that
the contractor would finance the costs through its own equity and
would expect a rate of return for equity of 29.2 percent. Under this
option's assumptions, construction financing costs would decrease to
$74.4 million in actual dollars and $47.1 million in 1998 dollars.
Like the performance-based option, other variables--namely, the
method by which the contractor finances the costs it carries and the
portion of costs financed by the government--could affect the
financing costs under this type of option.
TOTAL GOVERNMENT FINANCING
------------------------------------------------------ Appendix II:0.6
Total government financing of the Advanced Mixed Waste Treatment
Project would present the type of financing provided for in DOE's
traditional cost-reimbursement type of contract. Under a
cost-reimbursement contract, the government would issue a letter of
credit and the contractor would be immediately reimbursed so that the
contractor would not have to carry any of the construction costs.
Thus, the government would not have to pay any financing costs to the
contractor.
The financing costs presented in the other options all contain the
contractor's profit. A cost-reimbursement contractor would receive
some negotiated fee for work. According to DOE's guidelines, the
contractor could receive a maximum fee of 1.41 percent of the price
of a construction contract of this size. Contracts of different
sizes will incur different fee levels. Thus, assuming a construction
contract for $244.6 million, the government could pay the contractor
a fee of up to $3.5 million in 1998 dollars.
This financing option differs from the other options in that it
involves a cost-reimbursement type of contract instead of a
fixed-price contract. Construction costs under a cost-reimbursement
contract may not behave in the same way as under a fixed-price
contract. A greater risk exists that construction costs will grow at
a faster rate than costs under the discipline of a fixed-price
contract. Moreover, the original construction cost estimate may be
higher to begin with because of the lack of openly competed
fixed-price contracts.
(See figure in printed edition.)Appendix III
COMMENTS FROM THE DEPARTMENT OF
ENERGY
========================================================== Appendix II
(See figure in printed edition.)
(See figure in printed edition.)
(See figure in printed edition.)
(See figure in printed edition.)
The following are GAO's comments on DOE's letter dated May 27, 1998.
GAO'S COMMENTS
-------------------------------------------------------- Appendix II:1
1. Our reply to DOE's concern about our analytical model appears at
the end of chapter 3.
2. Our reply to DOE's concern about the flexibility contained in OMB
Circular A-11 appears at the end of Chapter 4.
3. We concur with this comment and changes have been made to the
text where appropriate.
4. The issue of the ways in which budget outlays may affect
decisions on how to pay for the purchase or use of capital assets is
addressed later in chapter 4.
5. Examples of the various scoring scenarios are given later in the
chapter when we discuss the ways that each of the model's financing
options might be scored for budget purposes.
6. The variables that affect budget scoring are too numerous and
complex for clear presentation in a table.
MAJOR CONTRIBUTORS TO THIS REPORT
========================================================== Appendix IV
RESOURCES, COMMUNITY, AND ECONOMIC
DEVELOPMENT DIVISION
Ms. Gary L. Jones, Associate Director
James NoČl, Assistant Director
Mark E. Gaffigan, Evaluator-in-Charge
Delores Parrett, Senior Evaluator
Robert M. Antonio, Senior Evaluator
SEATTLE REGIONAL OFFICE
Thomas C. Perry, Senior Evaluator
OFFICE OF THE CHIEF ECONOMIST
Joseph Kile, Senior Economist
OFFICE OF GENERAL COUNSEL
Susan W. Irwin, Senior Attorney
ACCOUNTING AND INFORMATION
MANAGEMENT DIVISION
Christine Bonham, Assistant Director
Carolyn Litsinger, Senior Evaluator
*** End of document. ***